Sunset Review of the Elected Officials' Retirement Plan, Public Safety Personnel Retirement System and the Corrections Officers Retirement Plan

Tami Stowe
Legislative Research Analyst
(602) 542-4962
Arizona House of Representatives
House Majority Research
REPORT
1700 W. Washington
Phoenix, AZ 85007-2848
FAX (602) 542-4511
To:
Date:
Subject:
JOINT LEGISLATIVE AUDIT COMMITTEE
Senator Blendu, Chainnan
Representative Knaperek, Vice Chainnan
December 16, 2005
Sunset Review of the Elected Officials' Retirement Plan, Public Safety Personnel Retirement
System and the Corrections Officers Retirement Plan
Attached is the final report ofthe sunset review ofthe Elected Officials' Retirement Plan, Public Safety
Personnel Retirement System and the Corrections Officers Retirement Plan, which was conducted by the Senate Finance
and the House ofRepresentatives Public Institutions & Retirement Committee ofReference.
This report has been distributed to the following individuals and agencies:
Governor ofthe State ofArizona
The Honorable Janet Napolitano
President ofthe Senate
Senator Ken Bennett
Senate Members
Senator Dean Martin, Cochair
Senator Ken Cheuvront
Senator Jorge Luis Garcia
Senator Jack W. Harper
Senator Jay Tibshraeny
Public Safety Personnel Retirement System
Arizona State Library, Archives & Public Records
Office ofthe Auditor General
Senate Majority Staff
Senate Research Staff
Senate Minority Staff
Senate Resource Center
Speaker ofthe House
Representative Jim Weiers
House Members
Representative Trish Groe, Cochair
Representative Jennifer Burns
Representative Meg Burton Cahill
Representative Steve Gallardo
Representative Marian McClure
House Majority Staff
House Research Staff
House Minority Staff
ChiefClerk
December 16, 2005
COMMITTEE OF REFERENCE REPORT
Senate Finance and House of Representatives Public Institutions & Retirement
Committee of Reference
ELECTED OFFICIALS' RETIREMENT PLAN
PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM
CORRECTIONS OFFICERS RETIREMENT PLAN
Background
Pursuant to §.~ - 953,ArizgJ1a Revised Statutes, the JoiritLe .slative.AuditCommittee
(JLAC) assigned the sunset reviewbfthe Elected Officials' Retiremen Jan(EORP);eublic Safety
Personnel Retirerriel1tSystem (PSPRS) and the Corrections Officers Retirelllent Plan(CQRP) to the
Senate Finance~q fIouse QfJ}~pr~§~J1~tives PublicIl1sti1:l.ltions&:J}etirelll~lltCoriunitteeof
Reference for review: .
The.~ORI?'Ya§established iri1970 to cover state and collilty elected officials, some city
elected officials aIldjudges. The PSPRS was created in 1968 to provide a uniform and consistent
statewide retirement program for public safety per§g~el~9~ghout the state. The CORP \V~
created in 1986 to provide retirelllent benefits for prison and j ail personnel ofcertain. state, SOtplty
and local governments. All threesystems were establishedto~dminister retirementbel1efits as well
as survivor,disability, and health benefits for eligible members and their beneficiaries.
The Fund Manager is a fi memberboardresponsible for the adlllinistration and investment
activities ofthe EQRP, PSPRS and CORP. The Fund Manager develops investment guidelines,
investment policiesartdfunding objectives with the assistance ofindependentinvestlTIentcounsel. A
fund Administratgr is responsible for collecting and refunding contribution§frommembers and
employers, disbursil1g benefits to qualified members in a timely manner aIld irl"esting.monies as the
Fund Manager determines necessary and prudent to meet investmentobjectives and accruing benefit
obligations.
Committee ofReference SunS'etReview Procedures
The Committee ofReference hel .bne public heating<Ol1 Wednesday, November 16,2005 to
review the Agency responses, as required by AR.s. §41-2954, subsections D and F, and to hear and
accept public testimony. Testimony was received from Jack Hacking, Administrator, Public Safety
Personnel Retirement System and Mike Colletto, Lobbyist, Professional Firefighters ofArizona.
2
December 16, 2005
Committee ofReference Recommendations
The Committee of Reference recommended that the Elected Officials' Retirement Plan,
Public Safety Personnel Retirement System and the Corrections Officers Retirement Plan be
continued for ten years.
Attachments
1) Meeting Notice
2) Minutes ofthe Committee of Reference Meeting
3) Agency factors pursuant to A.R.S.§Al:::49 ubsections D and F
4) Additional Sunset Document
5) PSPRS Presentation
6) Funding Status)mprovementOptions Document
3
Interim agendas can be obtained via the Internet at http://www.azleg.state.az.usllnterimCommittees.asp
ARIZONA STATE LEGISLATURE
INTERIM MEETING NOTICE
OPEN TO THE PUBLIC
SENATE FINANCE AND HOUSE OF REPRESENTATIVES PUBLIC INSTITUTIONS AND
RETIREMENT COMMITTEE OF REFERENCE FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEM
ELECTED OFFICIALS RETIREMENT PLAN
PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM
CORRECTIONS OFFICERS RETIREMENT PLAN
Date:
Time:
Place:
Thursday, December 1, 2005
1:00 p.m.
House Hearing Room 5
AGENDA
1. Call to Order - Opening Remarks
2. Arizona State Retirement System (ASRS)
• Presentation by the Auditor General
• Response by the Arizona State Retirement System
• Public Testimony
• Discussion and Recommendations by the Committee of Reference
3. Presentation of Elected Officials Retirement Plan, Public Safety Personnel
Retirement System, and Corrections Officers Retirement Plan
• Public Testimony
• Discussion and Recommendations by the Committee of Reference
4. Adjourn
Members:
Senator Dean Martin, Co-Chair
Senator Ken Cheuvront
Senator Jorge Garcia
Senator Jack Harper
Senator Jay Tibshraeny
11/16/05
jmb
Representative Trish Groe, Co-Chair
Representative Jennifer Burns
Representative Meg Burton Cahill
Representative Steve Gallardo
Representative Marian McClure
People with disabilities may request reasonable accommodations such as interpreters,/
alternative formats, or assistance with physical accessibility. If you require accommodations';'" /
please contact the Chief Clerk's Office at (602) 926-3032, TOO (602) 926-3241. ,....:/'
c/:."...~.:r.,./:<. ......J.. ...• " .
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ARIZONA STATE LEGISLATURE
Forty-seventh Legislature - First Regular Session
SENATE FINANCE AND HOUSE OF REPRESENTATIVES
PUBLIC INSTITUTIONS AND RETIREMENT COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEM
ELECTED OFFICIALS RETIREMENT PLAN
PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM
CORRECTIONS OFFICERS RETIREMENT PLAN
Minutes of Meeting
Thursday, December 1, 2005
House Hearing Room 5 -- 1:00 p.m.
Co-Chair Senator Dean Martin called the meeting to order at 1:30 p.m. and attendance was noted
by the secretary.
Members Present
Senator Garcia
Senator Harper
Senator Martin, Co-Chair
Members Absent
Senator Cheuvront
Speakers Present
Representative Gallardo
Representative McClure
Representative Groe, Co-Chair
Representative Bums
Representative Burton Cahill
Lisa Eddy, Performance Audit Manager, Arizona State Retirement System
Paul Matson, Director, Arizona State Retirement System
Keith Meredith, Chairman of the Board, Arizona State Retirement System
Anthony Guarino, Deputy Director of Arizona State Retirement System
Jim Hacking, Administrator, Public Safety Personnel Retirement System
Mike Colletto, Lobbyist, Professional Firefighters of Arizona
Lisa Eddy, Performance Audit Manager, Auditor General's Office, ASRS, presented the results
of the Performance Audit and Sunset Review on the Arizona State Retirement System (ASRS)
(see presentation handout, Attachment 1). A list of the findings presented is as follows:
SENATE FINANCE AND HOUSE PIR
COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEMS
December 1, 2005
1. The ASRS is generally managing its investments appropriately (p. 5, attachment 1);
2. ASRS should improve its performance in paying some benefits (p. 9);
3. ASRS may need to revise its plan to improve response times at its Call Center (p 14).
The presentation also included information on member and employer contribution factors, the
viability of the original retirement system and the agency's sunset factors.
Paul Matson, Director, Arizona State Retirement System (ASRS) mentioned that there were a
number of staff members of ASRS present and he introduced Dr. Keith Meredith who has been
Chairman of the Board for a little over a year. After complimenting the auditor staff on the
professionalism of the audit Ms. Eddy had presented, he referred to the handouts of the
presentation he was about to make (see Attachments 2 through 8). In pointing out Attachment 2
he stated he would be breaking it up into three sections: pp 1-16 about direct responses to the
Auditor General's comments; pp 17-31 strategic planning items at ASRS, and pp 32-34 - 2006
legislative initiatives for the State Retirement System. He summarized the findings as follows:
Finding No.1, ASRS investment management generally appropriate. The recommendation to
adopt the six draft policies has been approved. They cover such things as funding process, audit
process, appraisals and method of funding external investment managers in the real estate space.
Recommendation No.2, in respect to monitoring other states' policies and procedures in this
area, Mr. Matson reported that this was and is being done and will be continued. This
recommendation contained three sub-recommendations for improving benefit payments: 1)
timeliness of new retirees; 2) accuracy of new retirees' payments; and 3) timeliness of refunds.
He said a lot of the timeliness and accuracy issues will be resolved by an information technology
plan to be completed by 2007.
Regarding new retirees, the paperwork is to be done in ten days; this phase to be completed by
December of 2006.
Some of the minor inaccuracies were deemed to be a function of two areas: 1) inadequate
policies and procedures; and 2) inadequate training. The staff has now completed appropriate
training to ensure that there is a homogenous understanding of how to do the calculations; and
the update ofthe policies and procedures has been virtually completed.
Finding No.3, regarding the Call Center, Recommendation No.1 is to monitor secondary
reasons for calls. This is being investigated to determine if there is a combination of
software ability and time allocation to do so. At present he has different perspectives from
staff members and will continue the research over the next several months. The second
item in this regard is the number of FDE's required in the Call Center. There are two
different statistical analyses; one says 19 and one 24.
2 SENATE FINANCE AND HOUSE PIR
COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEMS
December 1, 2005
Co-Chair Groe requested of Mr. Matson that he elaborate on how he plans to make these
objections come to fruition when he discusses the second part of his presentation,
Continuing with his presentation, Mr. Matson reported ASRS has a plan that will invest 6
percent of the total fund invested in real estate -- geographically (nationally and possibly
internationally) and by product groups (office buildings, hotels, retail, storage, etc.). The
vast majority of assets, approximately 70 percent will be invested in core type real estate
properties which are typically higher grade, more liquid and close to major city centers like
San Francisco, Chicago, New York. Approximately 30 percent of these assets will be
invested in non-core, mostly opportunistic, investments. These are typically investments
through joint-venture projects. The current allocation for real estate is close to 0 percent.
Senator Martin asked about the general overall funding status to which Mr. Matson
responded that it was 86.1 percent, though it was expected to drop to the low 80s over the
next several years before it starts rising again; and that this rate is calculated by financial
analysts and is irrespective of financial tactics.
Senator Martin then asked about the turnover factor. Ms. Matson responded that some
would be five or more years; those more opportunistic, three years or less; that three or
four years would end up being an average turnover holding period for a property.
Senator Martin then asked how joint venture partners are selected. Mr. Matson explained
in detail the process of consulting a number of core real estate consultants and an internal
chief portfolio manager.
Mr. Matson reported that the Information Technology (IT) plan is scheduled for
completion by December 2007; within that framework an online website for members to
check their balance, their statements and what the records show as far as account name and
beneficiary is scheduled for completion by February 6, 2006.
Mr. Matson stated that the Call Center has now two types of staff members, one of which
is higher paid, who although they do not do financial planning or give advice, have benefit
advisor skills; the other type have call center skills. The first would be able to answer the
questions on the spot that now are being answered by "I'll do some research and get back
to you later." He reported that call time wait is now 3 minutes that he hopes to reduce it
further.
Representative Groe asked Mr. Matson to explain what checks and balances were in place
to ensure the success rate with as few employees as necessary. Mr. Matson answered that
their internal audit department would next be auditing the Call Center and the time it takes
to respond to calls.
3 SENATE FINANCE AND HOUSE PIR
COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEMS
December 1, 2005
Anthony Guarino, Deputy Director of ASRS, reported that the staff at the Call Center is at
the number that the Auditor General has recommended and will stay at that number unless
service deteriorates.
Representative Groe asked ifthere is a date for the internal audit. Mr. Guarino advised that
a new internal auditor was just hired and that it is part of his mandate to schedule it; that
Mr. Guarino would get back with a clarification of time schedule and details of what they
will be doing. He said that additionally the plan is to monitor the call service daily and
monthly report to the board of trustees.
Mr. Matson continued his presentation by giving summaries of his handout (Attachment 2)
focusing on page 25 "Vision and Values" and page 28 "Impact of Cost Reduction
Initiatives" and finally pages 33 and 34, "Legislative Public Policy Initatives for 2006."
Cochair Groe moved that the Committee of Reference recommend to
the Legislature that the Arizona State Retirement System be continued
for ten years. The motion carried approved by a voice vote.
The next speaker was Jim Hacking, Administrator for the Public Safety Personnel
Retirement System. (PSPRS) (Attachments 3 through 6). Mr. Hacking explained that
PSPRS is the administrative entity that manages and administers benefits for three separate
benefit plans in this state. All the retirement plans are authorized and operate under Title
38, ch 5, art. 3, 4 and 6 of the Arizona Revised States. It is governed by a board of 5
members all of whom are appointed by the Governor and two of whom must have some
investment expertise. The PSPRS has a system of 21 0 local boards that are responsible for
such things as determining eligibility to participate in the system, determining eligibility
for benefits and actually calculating the benefits that are to be awarded. The central office
monitors and audits the work that is done by the local boards of PSPRS.
In the case of the Corrections Officers Plan (Attachments 3, 4 and 7), they too have a
system of local boards, 19 of them, and they perform functions similar to those of the
Board of the PSPRS program.
Mr. Hacking then reviewed the options and constraints in trying to improve the fund (see
Attachment 3, pp 11 and 12). Considering the constraints he emphasized that if the only
thing to be done was that the amortization period was changed from 20 to 30 years, the
17.1 percent employer rate would be reduced to 15.44 percent in 2007; a 40-year period
would make it even less. He reported that he is having research done to see what would
happen if the salary growth assumption were reduced from 6 percent to possibly 5 or 5'ii
percent. He said that generally the result would be an improvement in the funding ratio of
the systems and a concomitant reduction in the required employer contribution. As soon as
he receives the projections from the Actuary he will share them with the Committee.
4 SENATE FINANCE AND HOUSE PIR
COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEMS
December 1, 2005
Mr. Hacking also suggested that consideration be given to making some changes in regard
to the Deferred Retirement Option Plan (DROP) either by setting a statutory rate or interest
to be credited to DROP participant accounts or imposing contribution requirements to one
degree or another on either the employer or employee or both.
Mike Colletto, Lobbyist, Professional Firefighters of Arizona, was asked by Representative
McClure what kind of action he would expect if the DROP program were continued for
those already in it, but otherwise eliminated, or if the rate of return was tied to the actual
interest rate that is in place by the federal government.
Mr. Colletto reported on a plan in which he has been involved and which is being called
reverse DROP. He stated that the firefighters have also obtained a constitutional attorney
who is reviewing both the constitution and case law. He said that the Firefighters' goal is
to work on doing everything possible within the constitutional case law to lower the
employers' contribution rates, and that they are actively working with them in that
regard; that the Firefighters care greatly about the financial stability of this plan because
they do not have social security.
Co-Chair Groe moved that the Committee of Reference recommend to
the Legislature that the Elected Officials Retirement Plan, the Public
Safety Personnel Retirement System and the Corrections Officers'
Retirement Plan be continued for ten years. The motion carried by a
voice vote.
Without objection, the meeting adjourned at 2:45 p.m.
Pat Hudock, Committee Secretary
December 6, 2005
(Original minutes, attachments and tape are on file in the Office of the Chief Clerk.)
5 SENATE FINANCE AND HOUSE PIR
COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEMS
December 1, 2005
6 SENATE FINANCE AND HOUSE PIR
COMMITTEE OF REFERENCE
FOR THE SUNSET HEARING OF:
ARIZONA STATE RETIREMENT SYSTEMS
December 1,2005
Sunset Factors
PSPRS
In accordance with A.R. S. §41-2954, the Legislature should consider the following
12 factors in determining whether the Public Safety Personnel Retirement System,
the Corrections Officer Retirement Plan and the Elected Officials' Retirement Plan
should be continued or terminated.
1. The objective and purpose of establishing the agency.
The Public Safety Personnel Retirement System (PSPRS), the Corrections Officer
Retirement Plan (CORP) and the Elected Officials' Retirement Plan (EaRP) were
established to administer retirement benefits for eligible members. The PSPRS
was created in 1968 to provide a uniform, consistent, and equitable statewide
retirement program for public safety personnel employed by the State or by
political subdivisions of the State. The CORP was created in 1986 to provide
benefits for prison and jail employees of certain state, county and local
governments. The EaRP, created in 1970, has evolved to cover state and county
elected officials, judges, and some city elected officials. In addition to retirement
benefits, survivor, disability, and health benefits are also provided.
The Fund Manager, consisting of five appointed members, is responsible for the
administration and investment activities of the PSRPS, CORP and the EaRP.
The Fund Manager develops investment guidelines, investment policies, and
funding objectives with the assistance of independent investment counsel. A fund
Administrator, employed by the Fund Manager, is responsible for collecting and
refunding contributions from members and employers, disbursing benefits to
qualified members in a timely manner, and investing monies as the Fund Manager
deems necessary and prudent to meet investment objectives and accruing benefit
obligations.
2. The effectiveness with which the agency has met its objectives and purpose
and the efficiency with which it has operated.
In general, the Fund Manager has been effectiv~ in providing retirement income
and, as the Fund Manager deems necessary and prudent, other benefits to eligible
members at the lowest reasonable cost. According to agency personnel, as ofJuly
2005,9,816 members are receiving monthly retirement benefits from the PSPRS,
CORP, and EaRP. We also have 28,864 active members participating in the
three plans. The cost of providing these benefits has been kept low due to the
solid investment performance of the funds. For example, annual reports for the
PSPRS, CORP and the EaRP indicate the funds have continued to outperform the
market indexes and have exceeded the actuarial yield on a long-term basis.
Additionally, the administrative cost to provide all mandated benefits and services
to all plan participants is approximately 4 basis points. This equates to $69 per
7. The extent to which the Attorney General or any other applicable agency of
state government has the authority to prosecute actions under the enabling
legislation.
A.R.S. §38-848(M) authorizes the Attorney General or an attorney approved by
the Attorney General to represent the Fund Manager in any legal proceeding. At
present, a private law firm is representing the Fund Manager in several cases that
are in litigation.
8. The extent to which the agency has addressed deficiencies in its enabling
statutes which prevent it from fulfilling its statutory mandate.
Numerous technical and administrative changes have been made to statutes
pertaining to the PSPRS, CORP and the EORP over the years. However, these
changes were made to either clarify statutory language or bring state statutes into
compliance with federal law. According to agency personnel, there are no
deficiencies in the enabling statutes of the three plans that prevent the system or
its personnel from fulfilling their statutory mandates.
9. The extent to which changes are necessary in the laws of the agency to
adequately comply with the factors listed in this subsection.
No changes are necessary at this time.
10. The extent to which the termination of the agency would significantly harm
the public health, safety, or welfare. .
Certainly, the Legislature could terminate the administering agency. However,
the retirement, survivor, and disability benefit entitlements of the PSPRS, CORP,
and EORP participants could not be changed, since these participants have a
constitutionally protected property interest in these benefits. Therefore, even if
the system were terminated, the state would still need an administrative
mechanism to distribute benefits and it is doubtful that one could be created or
otherwise found that could perform this critical function as efficiently and cost
effectively as the existing entity has done for so many years.
11. The extent to which the level of regulation exercised by the agency is
appropriate and whether less or more stringent levels of regulation would be
appropriate.
Since the agency is not regulatory, this factor does not apply.
below the peer average of $87, as reported by the Cost Effectiveness
MeasUrement (CEM) Benefit Administration.
3. An identification of any other agencies having similar, conflicting or
duplicate objectives, and an explanation of the manner in which the agency
avoids duplication or conflict with other such agencies.
The responsibilities ofthe PSPRS, CORP and EORP do not overlap with any
other board or commission. The agency is, by statute, specifically dedicated to
serve certain, very well-defmed, constituencies.
4. An assessment of the consequences of eliminating the agency or consolidating
it with another agency.
Elinllnating the existing agency would remove the mechanism that provides
retirement and other benefits for state and local public safety personnel, various
state, county and municipal prison and jail employees, and state and county
elected officials, judges, and some city elected officials. Although the state
legislature could create or otherwise designate, another administering entity to
provide the benefits and services for which the existing agency was designed, it is
highly doubtful that such other entity could provide the mandated benefits and
services as efficiently and as consistently cost-effectively as the existing agency
has done over so many years.
PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM
CORRECTIONS OFFICER RETIREMENT PLAN
ELECTED OFFICIALS'RETlREMENT PLAN
3010 East Camelback Road, Suite 200
Phoenix, Arizona85016-4416
www.psprs.com
TELEPHONE: (602) 255-5575
FAX: (602)255-5572
James M. Hacking
Administrator
September 13,2005
James A. Nielsen
Assistant Administrator-CIa
Tracey D. Peterson
Assistant Administrator-COO
Representative Trish Groe, Co-Chair
Committee of Reference
Arizona State Legislature
1700 West Washington Avenue, Suite H
Phoenix, Arizona 85007-2844.
c/o Tami Stowe
Committee Research Analyst
House Public Institutions and Retirement
Committee
Dear Representative Groe:
In reply to your letter of July 27th, I have enclosed for your review: (1) the responses ofthe Public Safety Personnel
Retirement System (PSPRS) to the factors identified in A.R.S. 41-2954 that are used in the sunset review process required by
Title 41, Chapter 27; and (2) the most recent (FY'04) Comprehensive Annual Financial Reports (CAFR's) for the Public
Safety Personnel Retirement System, the Correctional Officers Retirement Plan (CORP) and the Elected Officials Retirement
Plan (EORP).
As soon as the FY'05 Financial Reports for the three plans are available, I shall forward them for review to the sunset review
Committee ofwhich you are Co-Chair. Those reports should be available soon.
Your July 27th letter also asked for a description ofthe composition and manner ofappointment ofthe Fund Manager and a
description of any recent major activities, projects or accomplishments.
The Fund Manager's composition and manner ofappointment is as follows. The Fund Manager is composed of five members,
all ofwhom, as of August 6, 1999, are appointed by the Governor for three year terms. In addition, as a result oflegislation
enacted this year, both the "employer" and "public" members of the Fund Manager must have substantial investment .
experience.
The Fund Manager is responsible for investing the system's combined assets, setting the employer contribution rates in
accordance with the annual actuarial valuations ofthe plans, collecting contributions from employers and participants, adopting
an administrative budget, hiring personnel to administer the system, setting up records and accounts for all members, paying
benefits to those eligible, establishing policies to govern all aspects of system operations and overseeing the administration and
security aspects of the system, including (in the case ofthe PSPRS and CORP) coordinating with the System's network of
Local Boards.
September 13, 2005
Page Two
With respect to recent major activities, projects or accomplishments, I would point out that, for the fiscal year ending June 30,
2005, the System had a combined total rate of return of9.11% which compares favorably to the 6.32% rate ofreturn ofthe
weighted composite market return benchmark against which the System's performance is evaluated. Over the 3, 10, 15 and 20
year periods ending June 30th
, the System's total returns were 10.20%, 8.18%, 9.03% and 10.12% respectively. These too
compare favorably with the benchmark returns for the same periods of6.96%, 8.06%, 8.61% and 9.50%.
With respect to the System's expenses for FY'05, benefits paid to the System's retired members and other beneficiaries
increased from $229.9 million in FY'04 to $257.4 million in FY'05. Although total administrative expenses also increased
(from $ 1.6 million in FY'04 to $ 2.3 million in FY'05), the System's administrative and investment-related expenses were
only between 4 and 5/100's of 1% (between 4 and 5 basis points) of the assets under management - a cost that is very low
relative to the administrative and investment-related costs incurred by other public retirement systems.
To accommodate the System's increased staff compliment that was necessitated by the service requirements ofour increasing
number of members and participating employers, the System's administrative offices were relocated to a larger and more
secure facility in Phoenix. The administrative staff also initiated a document-imaging project in order to have a secure and
easily retrievable copy of all System records. In addition, the Fund Manager completed a governance and investment policy
review so that the System now has a written and comprehensive compilation of charters and policies governing all aspects of
System operations. Finally; in order to buttress the System's internal control structure even further, the Fund Manager
approved the addition of a Compliance Officer position; that position will be filled as of September 19th
•
Should anything further be needed from PSPRS to facilitate the Committee's review process, please do not hesitate to contact
me. I can be reached at 602-296-2527. My e-mail addressisjhacking@psprs.com.
I~- ~~~
es M. Hacking
dministrator
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Total Plan Statistics
Defined Benefit Plan
Active Members
Terminated Vested Members
Drop
28,850
321
1,472
Retired
Normal
Beneficiaries
Disability
Total Participants
6,672
1,408
1,110
Total fund
9,190
39,833
2
Total Plan Statistics
Defined Benefit Plan
As of June 30, 2005
Actuarial Value Market Value*
Assets
Funding Ratio
As of June 30, 2004
Assets
Funding Ratio
*Market Value minus Future benefit Reserve
$6.1 Billion
84.60/0
Actuarial Value
$6.0 Billion
94.6%
Total fund
$ 5.1 Billion
70.80/0
Market Value*
$ 4.7 Billion
74.40/0
3
Total Revenue
June 30, 2005
Court Fees
$3,792,729
1%
Employer
Contributions
$124,093,577
17%
Employee
Contributions
$106,154,603
15%
Service Purchase
$15,071,130
2%
Total fund
Investment
Income
$477,214,755
65%
4
Total Expenses
June 30, 2005
Normal
Retirements
$219,738,906
64.10%
Admin Exp
$2,653,622
0.77%
Transfers
$1,489,809
0.43%
Deferred
$131,285
0.04%
Refunds
$24,383,088
7.11%
Insurance
$14,994,508
4.37%
Drop
$15,265,160
4.45%
Suvivor Benefits
$32,900,721
9.60%
Disability Benefits
$31,262,170
9.12%
""""""'.""'$,·.:<'_,;r-"'''"'''·'''''''''_u'''',.m'''.......'''r~''''''''''''''·;'''''''''''""''''''"·.,·,_··.'''~,,;.,"'''''''''''.''''',=''e_·~·.:'''·_ ....'''','''.,.,·''''"""''''·_''''_''''''''''._~''' •...-N~·r."'-•.,.~"~.w"'..~._ ......~'m"'.,'~,_ •.,,"''''''''',,..'''''',._,..,''','''''·,'''.'''~)!'_n ",.·'"',.,."'_~...""'".."~"<""'~,-"...,.-""'><.w"".". ...""'''''''''';''·'''*''......,.·I'''''.'''£,v,,,,''''..,.·r"''''u·...y"·;¥>.....,~'''''.·.w'''.,, ..i~'''.~''''''',.'''r,~''''w''If''''.~'''moM'-''''"-mo." ""'''''~''''''~N'''_...,....J''''''"'''''''''''',,,._'.,''''>'M''''''.~'','-''<..,'''''''''''_·'''''''·' __''''''''''''''"m''W~,.._""'''''',,~,~',·."''M'~''''~·'''''''_·.'''M$
Total fund 5
Net Cash Flow
FYE June 30 (thousands)
$20,000 I I
$0
($80,000) -!-I -----l
($60,000) ...LI------------------------..,
($20,000) ...LI--------------
($40,000) +-1--------------------1
($100,000) +1--------------------------1
($120,000) -I 1996 1 1997 I 1998 I 1999 I 2000 I 2001 I 2002 1 2003 I 2004 12005 I
Net Cash Flows 8,564 I 5,697 I -7,328 I -15,146 1 -36,684 1 -55,531 I -79,427 1-108,6261 -93,378 1 -93,707
EE-ER Contributions - Benefits Payments and Expenses
Total fund 6
Asset Allocation at Market Value
June 30,2005
Bonds
$1,130,481,255
20%
Real Estate
$240,250,666
4%
Cash $339,316,158
6%
:_"_"""'''''''''''__A'''''''j\/'_'''__"f~'''_'''''''''''''''''~·''''''''''''1rnr",m..,.",''",~lIl'''''''''''''''''''''""",_."~,_,~-_. 1'""'_~""·";''''"'''''''''''_AA!M.'''';;:mi''1<.-':''''~'~·I<-''''',*~N'''"<'_"".•.,""'""""",'1<""'__,__="','_""""'.,"".,.....·""',.'WI"""""""·mo»M.O<\I"·:~_,_ •.__·""";~~·~_·,"".'1 ..U... ,.,..,,'"!"~'""· .....__fO=i~'..-"""'._ff"'''''''''-~~''..n.''*'1'lI1\lOO»;<,,_JI>',""''''''''''',''''''',,·.,,~~ __~'''''·.~"'B'~''''''''.'..''_,,·~;,'''·~~lil'·''''''' ...._··Mn''''''''"
Total fund 7
00
nvestment Portfolio Returns
June 30,2005
Total Fund
Benchmark*
ASRS
COPERS
1 Year
9.2%
6.3%
8.5%
8.6%
3 Year
10.2%
7.0%
9.2%
9.2%
5 Year
-1.1%
3.0%
2.2%
3.7%
10 Year
8.17%
8.0%
9.4%
n/a
eBenchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% J-fBill
!,)t und 9
Total Fund vs Benchmark
June 30,2005
25.000/0-" i
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
-20.000/0fiiii9~k6k T* igig;W *Twiggs' 'T@l ii999'UT& &20&00% r 2ooi'r 2oo~kM'l '6Sii;003 1M§! r;,,~oo~§ 'ilrhi;005whr
(I Total Fund I 16.40% 123.42% 1 22.11% I 17.67% 1 12.47% 1-16.89%1-15.04% 1 6.61% 1 14.94% I 9.15%
EJ BenchlTark* I 13.98% I 17.87% I 17.66% I 11.94% I 5.75% I -1.07% I -4.13% I 6.18% I 8.38% I 6.32%
,..,.r_1"'''''''''''''A<~'''1!<'''''',"",:''''-''''''',",,'''<»'''Mf''"''''''''''''_'''"''~·_='''''''';' .''''l''I1''''''''__'''''''r~''_''"'~~·~'"''''';<·''~~'''-'''''''''''''''''''.''''''''''''''''''''lir""",<,'·'''''''''''''''~·_',~"_"~"'"'...,,"'M'i(l'M"<Jt.<.rM'_#1\m"·"'_"'-',.....""""""j""""""""'~'n ·...'d'ill~'"'~·'f'~.""'"n"";n''''·'''·,.''''''l'\'='''("...''.I.N~>"I.;1~''','".''''"''''' ..'''-<"'..~')''',.'''~r'''O'"et~, ",." •.~N__·«i'''..,.._~·~;''''...·,,''''';,...~'_.,,·M.,''''d< ..<;'''.y'''_~,,:\'""'""~ ..=""~""~._,,:,''''<'''.''''.~r·''''"'' ..'>;,-,.,,>''''''~...,.·'"
-Benchmark 45% sap 500, 45% Lehman Gov/Credit, 10% T-Bill
10
Total Fund Actuarial Assets and Liabilities
June 30,2005 (thousands)
June 30, 2005
. $6,104,548
ITotal Liabilities $6,292,02911 Total Liabilities $7,218,720 I
I II I I Funding Ratio . 94.5% I I Funding Ratio 84.5% I
L.__.__...__........._..._..._.J I................__._.__._....__.___....J
""'lI;Wm""..,,'''''''''''~'_·''"· __...'»·...._'>l..,_'''''f''.'''"'''"'..wn........''''r~.m'''.''i'~.~~·~'''' ...'''''~~·~",.,,'''_.''''_".j.''' ....,''''''''"'''''''''''.......;..._,,".'''''.''i''='''''''''''''''"'''''..#.~,""""\ ...."'n,_.~..m"·,...__r:p"'''<~·H'''',._~~,_'''''~M., ....'~'''''''.<, ,-__.,\,~~·'"',.,"r""i""~,.""..,";"""'."""'_"'"_"'="""'"'"''''',.__,':'J'=.,"'"'''",.~"'"'~...oO-·._.."~.~" ...". """"~,·,,_,"""'~""""'"'~~., __.,,_~...,,.,,"''''',.~I'l''_,.'''''w''''> ""''''\_''_'>''n'~''IJa'''',''_~.
Total fund 11
Book Value vs Market Value
June 30, 2005 (millions)
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0,
1996 I 1997 I 1998 1999 2000 2001 2002 2003 2004 2005
Ill} Market I 3,355 I 4,137 I 5,034 5,897 6,589 5,431 4,548 4,725 5,325 5,708
o Book I 2,838 I 3,161 I 3,530 4,291 4,718 4,939 4,973 4,416 4,501 4,736
Total fund 12
-----
.... - ~ ~
¥"''''''''''''!''"''''ft'__rr~'_''.''-'''1WI1O''''J<-M'''1<''",""",''--''';''';''''-;<l'''''''''''''''''''''\'''''!:''''''"""""'-,"",_.>\.,_....,_..m"",__..._..~l!o/,.~ ..."~""',.-.....,."-"'~,,,'\1"-«I;''''..m,,~.,.''''''''''''''''''''''''''''''"''''''.!!''''.'.'.=.,''''''''y''''"''''''''''',','''''''."~..-t<!,..~"'''''''''''~.'''''"'l''"I1''''''';;.-'''"_~_ ....':""""'_'"~ •.,~''''',,,''',·'''':''''''''''·.'''''''''''.,.,. __,,.m_''"' ',,I\'W,~·.11>W'T,f:.1'?I«""'\...,"""'.~'''''''W'lm~'''''\\','~~,''''' ..'.''-r''W.,.iJ'''''''-...'..'':'',~.WN'M''''j~-~""n:;-,_.·"""··~'"""''''_~,.~,,\'''W' ..,<l
Investment Expense (% of Assets)
0.400% I i
0.350%
0.300%
0.250%
0.200%
0.150%
0.100%
0.050%
0.0000/0Iii I I I i I I I
9){o
~
~
~
~
~
~
~
~
~
~"Y
~
~
~
~
~
~
~
~
~
-Total Fund CEM Benchmark Calculation
-CEM US Universe - NASRA Public Fund Survey- Median
-NASRA -Public Fund Survey- Average
"Comparison of costs to the universe must be interpreted with extreme caution given the breadth of the
universe which encompasses funds with widely varying size and asset mix. Your benchmark cost calculation,
is a much more valuable indicator as to whether you are a low or high cost producer since it adjusts for
differences in fund size and asset mix," Cost Effectiveness Measurement Inc, 2005 pg 12
!'(!l~M""'~""')_'''''o1<''~_,t;;I''~<')'''''''''.w''''''''~·~"'''''''''''' ...""_~n'''':,,--,,, ,;~",~·.·",,,,,",,,,,,,:,<,,,,·~,,,",,",_~_Yj>,n,"><-""i"'''.''''''''''''''''_;'~· f~"""·~".·;,~",.,,,·,., •.,,·.~t,..,.. .. fi""""''''''?''''"''''-ll'-~_~''''~i'' '.e,~-"W,,,,,,,,,,,,,-,,,,",,,,,,·,,,,,,,,,,,",r,-,,,,,,;o;,,,,,,·.,,";~n"':,,,,,,,,,_-,,,,~.;;,''''''''''~''''''''''''''"''~'''''""-"""·;·"....,~~;w"t·;~-"' ..~...,~~"'"'"''''''',;; ....~"l>l.,..J-'';''',;;.'''"''n''''''''',.l''#;i!'_'-',, "·!IM"·"'''''''i!'~·t.M"."',;I'''"''''''''''''M_"",,,,,,~'''''''~~'",'':ll''''''''_'$'''''''"W·_"!I?')~"'''''~'¢')._·'''''~'_''~.''''''M''''·X·'':' __-'·'<%M~'!!_
Total fund 13
Cost Effectivene.ss Ranking
2003 An Funds Value Added vs Excess Cost: Arizona Public Safety
Retirement Value Added S.2°la vs Excess Cost -26.2bp
a
::l
re
:>
Added & Lj"
00
00
o
~ Va.lue
Added & tiigh
o Cost
o o
Low Vafue Added
& High Cost
CostiEffectiveness :Ranking
2004 AU Funds Value Added vs Excess Cost: Ari:zona Public Safety
Retirement System Value Added 1.7% vs Excess Cost. -23.8bp
o
Added & High
Cost
o
°
o
°ro 6b
o
o
o
o 0o°
Added & Low
Cost
o
"0
'OJ
"'0
"0 «
4)
:::l
ro
>
o
Low Value Added
& Low Cost
Low Value Added
& High Cost
"t . I
Excess Costs
Administrative Expense
(% of Assets)
/ "',
/' ~
~
./
- ....-- ----- .-/'
I I
0.120%
0.100%
0.080%
0.060%
0.040%
0.020%
0.000%
t;Jjfo
~
~
~
~
~
~
~
~ ~ty ~ ~
~ ~ ~ ~
~ ~
~ ~
-Total fund -CEM US Universe
- NASRA Public Fund Survey- Median -NASRA -Public Fund Survey- Average
"IIr1\~""",,_,"'''''''''"''''''''''._,",,",=''''''''''~-''''''''''''''''''''''~'''l>o.,.'''''''''''''''''''_'/M11fI~'''''~''!'Il<N\>l!'''''''''_''~l'I'M'"'_f;' _"li"""""~"'__~_!''''',(_''''''''''~'''..l''I''''''''·'>W>~-=''''''iMl.'_'''';'''_~,''!'<;<;;;_.-:f(NW'"'·"_"'.<".I....,...._..'<I'-"'='.,:'ffl"__.f"".m~""'''''=.'''''''''''''',_,·~.i!I'fi>'ll'O'''''''t_·.;''''"~MIl'."~"..~.r~"".;""'r_1'1>"1t'''''''*,'.J''I<l\r'''''~";;_~_''''''.'''''''~'''_,'''".;~:·.-'.,.1<."",""",,#",o,=_~~,·"".,","".'''''''"'-~''''-''''-''''''.1'''_'''''
Total fund 16
Changing Financial Status
FYEJune 30
Actuarial Actuarial
Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $2,988,962 $2,776,920 107.6% $3,212,775 115.7%
1997 $3,523,112 $3,058,978 115.1% $3,802,525 124.3%
1998 $3,919,467 $3,354,191 116.8% $4,465,855 133.1%
1999 $4,584,740 $3,752,978 122.1% $5,068,417 135.0%
2000 $5,294,936 $4,169,958 126.9% $5,619,426 134.7%
2001 $5,793,886 $4,480,132 129.3% $4,688,260 104.6%
2002 $5,818,181 $5,056,396 115.0% $3,987,904 78.8%
2003 $5,946,631 $5,746,803 103.4% $4,207,661 73.2%
2004 $5,951,310 $6,292,029 94.5% $4,682,652 74.4%
2005 $6,104,548 $7,218,720 84.5% $5,108,036 70.7%
'''·''''''~·M",,''m~»·,'''''''''''>'M'''.'''''''''"''''''''''''',-.''.';'''·>.ct.'~·~~~:,".r'-'''~''''''M:-.'~<''''''''~;,~'''''"'~''')'''''''>''-''''''.n",'_",,''_''',..,'M<""",,.,,,'''''''''',....,.,,,,,<·,''',,'''.'.'...''M''
"Market Value minus Future benefit Reserve
Total fund 17
Z
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en
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PSPRS RATES OF RETURN
Estimated
S&P 500 S&P 500 S&P 1500 S&P 500 S&P 500 S&P 1500
Balanced Actual Actual Balanced Actual Actual
Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD
PSPRS CORP
07/31/05 3.3% 3.3% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6% 3.3% 3.3% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6%
08/31/05 2.0% 5.3% 0.3% 1.5% -0.3% 2.1% -0.4% 2.2% 1.9% 5.3% 0.3% 1.5% -0.3% 2.1% -0.3% 2.2%
09/30/05 0.5% 5.8% -0.2% 1.3% 0.3% 2.4% 0.3% 2.6% 0.4% 5.7% -0.2% 1.3% 0.3% 2.4% 0.3% 2.5%
10/31/05 -1.5% 4.2% -1.1% 0.2% -1.3% 1.1% -1.4% 1.1% -1.5% 4.1% -1.1% 0.2% -1.3% 1.1% -1.4% 1.2%
11/30/05
12131105
01/31106
02128/06
03/31/06
04/30/06
05/31/06
06/30/06
EORP TOTAL FUND
07/31/05 3.1% 3.1% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6% 3.3% 3.3% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6%
08/31/05 2.0% 5.2% 0.3% 1.5% -0.3% 2.1% -0.4% 2.2% 2.0% 5.3% 0.3% 1.5% -0.3% 2.1% -0.4% 2.2%
09/30/05 0.4% 5.6% -0.2% 1.3% 0.3% 2.4% 0.3% 2.6% 0.4% 5.8% -0.2% 1.3% 0.3% 2.4% 0.3% 2.6%
10/31/05 -1.6% 4.0% -1.1% 0.2% -1.3% 1.1% -1.4% 1.1% -1.5% 4.1% -1.1% 0.2% -1.3% 1.1% -1.4% 1.2%
11/30/05
12131105
01/31/06
02/28/06
03/31/06
04/30/06
05/31/06
06/30/06
S&P 500 BALANCED INDEX - 45% S&P 500 + 45% Lehman + 10% 91-Day T-Bill
S&P 500 ACTUAL WEIGHTED - Actual asset allocation percentages applied to S&P 500, Lehman, 91 Day T-Bill Indices and Expected Annual Return for Real Estate
of 8%.
S&P 1500 ACTUAL WEIGHTED - Actual asset allocation percentages applied to S&P 1500, Lehman, 91 Day T-Bill Indices and Expected Annual Return for Real
Estate of 8%.
!~Iit~
i:
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.~
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,
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IC
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10 !I
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letS II IE ~"eD I­i
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10 !~ 10- IleD i.e
II- i,
CORP ~ Funding Levels
160.0% .--------------------.
140.0% +1--
120.0% +1--1
100.0% +1--1
80.0% +1-----,
60.0% +1--
40.0% +--
20.0% +--
0.0% -'---
06/30100 06/30101 06/30102 06/30103 06/30104 06/30105
IFunding 140.6% 140.0% 123,8% 106.9% 104.8% 96.4%
3
EORP - Funding Levels
160.0%
140.0% ~ I I I
120.0% I I
100.0% I I
80.0% I I
60.0% I I
40.0% I Fe·
20.0% I I
0.0%
06/30100 06/30101 06/30102 06/30103 06/30104 06/30105
IFunding 130.1% 141.7% 125.5% 118.7% 104.4% 95.5%
m."'~""-,'I'''~''''lN'''')<;'''""",''''''''''''''''''''''''''''''''"".iWAI_'''''·''''~M<n",,,,,,w''.'_~~,,w:.'g,,,·m.''''"''''~·<·'·''_<'''·'~·'"'''''_·;~-''"~~"'·''''~'''-·'''''M'''.'~'''''".~..'.;·:".',··".<"."ot".;"".""'"..-"""',,·,~ •.''''·~·,...,..,...,,''~.~'.'*'''''.il.w""""";_",_,,,,,,,,,."';''''''''''"_t'I_·,,,,y.·,;;,·,,,. ..,~".,,,~y.;[~·;;-,,~.,''-t'U."'.t'"f<''''''.'''~''''~''~.''''''~.,1'1I:'-''''M'.'''_,'''l<''~'''~',"''''AA''''''''.''''W'''~e";Y~~~"'c':~""~""""'~" __M""""."~"""_M"'y',"'-""T.'''''W",¥~",Ili'';.~.j'''''~·,"""""""""~'""U"",,,,,,,,.,,,,,.,,,,,,,,,-,,,,,,,,,,e''''>;,""'':\';J'''':lJ'''''''''''M'!'J''')"'''''''''''''J'-'''",,,,,,0\\,,,
4
PSPRS - Aggregate Employer Rates
18.00°1<)
/ ) / I /' ) ./ .
) ~
)) - / / ) -- .....,...
)
)
2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
IRate* 4.21% 3.75% 7.66% 10.05% 12.80% 17.09%
*The aggregate computed contribution rates before application of the statutory minimum
5
CORP - Aggregate Employer Rates
) _.
) / ) / ) ./ ) /' ) / ) ~ - )
)
2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
IRate* 1.15% 1.71% 3.95% 4.07% 5.47% 7.01%
1
o
2
3.
4.
8.00%
5.
6.
7.
*The aggregate computed contribution rates before application of the statutory minimum
6
EORP Employer Rates
) -- ------_.---
)
./ii.:·
)
:"
.. /
)
... :.:<:i·:P:
,0%$,·,",",04"
)
.,6//
i
<:!!Pi,::i/ii/
4
/
)
)
2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
IRate 6.97% 7.55% 13.49% 14.54% 20.54% 24.27%
5.0
0.0
10.0
15.0
20.0
30.00°1c
25.0
,.,"""".,.."""'_iOllil\\\1O"""""__....'''.._''M1':~''..''''''''~_''M"__''''t''"'m'''''...''''''''_..._~l(;>!),"'"',__1'l""',-"','>,...""""lW!""'"_,......'l'<,"""'"·"""',.'f;Offi'$'=.·i..."""''''"''''''".,,,,,4<,.....m''''....,..,I''''__'''''''"..~''''''''''wf'''','''''i%N:..."..,,''"''''''''''~l'l''''''''..'.'.';'''"_''''''''''"...-OC.'~~1oll""""""'",.."~""M;''''".,'''''''" .._,\'',·'''''''"'''O<'.i'I1<="'''",-'''*'''',.,,'''~'*''-''" ,,,."'''''''''''1\"'''*.'''';j<'''t~.,.,,·'''''''''''''',..."m'"''·-"'.'',·''')=7'''~.,''',.,;'''''''';'''~J.'.'~M'r:'O~"""f",'''.,,,,'-;''''''',=''',,, .....,.'!lM',''';:':.....,,''''<~·(, '~","
7
State Agencies for Fiscal Year 2006-07
Required Contributions by Plan
Plan Payroll Contributions
PSPRS Agencies $ 76,373,087 $ 17,207,323
CORP Agencies
EORP Agencies
$ 295,772,278 $ 21,126,372
$ 16,034,649 $ 2,725,890
9
ontributing Factors
Significant loss in asset values
o 2001 through 2002 financial market contractions
Current investment environment
o Not as robust as last half of 1990's
o Reduction to actuarially assumed rate of return
Pre-funded post-retirement benefit increases
Recent benefit improvements
o Deferred Retirement Option Plan (DROP)
o Increases in survivor benefits
o Permanent 2% tax equity benefit
Certain changes to economic and demographic
actuarial assumptions
""'JIl""""""=·"'~_·M_~·_i!!.~QI.'W'''''~'''''''''',""""""",~m''.'''~d",~~"""""";...,.~,,,,..,.;.,,,,,."~"""""">i"""'M"'H",-",,,,,,,..~.,,,,,,,··,;,,,,,,, ....,,,,,,,",,,,"'·'~W""iq,,,,,,,,,,,,,-·,,,'''''''.'''''''''''''~'_~''''"'''''''''~'''''''''_''_,~''''_~·''''',""·l'-'''_'''''''',·,=~''1'f,,, -"'""""·"""' .•,',....U".""".,,.,~.il"'.,~__.·~~""__-''''''''''''''.=.·,'''},,...~.fO...._~""."""...""""'''''''_'''"..''''''__. -_~.,...'"...,="....,...~,,.,M%' .."'."""'I'>'"""""_'''''''''''''"".',-''''''''_......~..·..'''·'"~'''''MJ>_'~_"'i"'''~1''"'J,. .•.•
10
Constraints
Prohibition against diminishment of pensions
o Arizona constitution
o Arizona case law (Yeazell v. Copins)
Political Constraints
11
i!I
o
o
o
Options Available
Reducing the System's salary growth assumption;
~~~ Considering a change in actuarial methodology;
Lengthening the PSPRS unfunded liability amortization period;
~~ Marking to market the PSPRS Plans' real estate and other alternative
investments;
Reviewing the PSPRS Plans' asset allocations;
New asset classes
Greater exposure to certain existing asset classes
Broader mandates for existing asset classes
Re-examining the treatment of the assets in the PSPRS Plans' Future
Benefits Increase Reserves;
til Increasing employee contribution rates;
If Reducing the rate of interest credited to PSPRS DROP accounts; and
Assessing contributions with respect to compensation paid to future
PSPRS DROP participants.
12
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Plan Statistics
Defined Benefit Plan - June 30, 2005
Active Members
Terminated Vested Members
DROP
16,317
104
1,472
Retired
Members
Beneficiaries
Disability
Total Participants
4,733
943
1,012
PSPRS
6,688
24,581
2
Pian Statistics
Defined Benefit Plan
As of June 30, 2005
Actuarial Value Market Value*
Assets
Funding Ratio
As of June 30, 2004
Assets
Funding Ratio
$4.9 Billion
82.1%
Actuarial Value
$4.8 Billion
92.4%
$4.1 Billion
68.4%
Market Value*
$3.7 Billion
72.4 %
*Market Value does not include Future Benefit Increase Reserve
PSPRS 3
Total Revenue
June 30, 2005
Investment Income
$383,530,412
68%
Employer
Contributions
$104,497,150
18%
PSPRS
Member Contributions
$67,947,506
12%
Service Purchase
$9,156,465
2%
4
Total Expenses
June 3D, 2005
5
Transfers
$259,692
0.1%
PSPRS
Administrative Exp
$1,599,784
0.6%
Refunds
$7,647,443
2.9%
Insurance
$11,417,919
4.3%
Drop Benefits
$15,265,160
5.7%
Survivor Benefits
$25,357,132
9.5%
Disability Benefits
$28,883,283
10.8%
Net Cash Flow
FYE June 30 (thousands)
($10,000)
($20,000)
($30,000)
($40,000)
($50,000)
($60,000)
($70,000)
($80,000)
($90,000)
($100,000) I 1996 -
• Net Cash Flow I -7,198
1997 I 1998 I 1999 I 2000
-12,670 I -26,585 I -33,085 I -51,231
2001 I 2002 I 2003 I 2004 I 2005
-60,493 I -71,174 I -97,205 I -85,416 I -85,224
EE & ER Contributions less Benefit Payments and Expenses
PSPRS 6
Asset Allocation at Market
June 30,2005
Cash
$279,083,870
6%
Real Estate
$194,104,748
4%
PSPRS 7
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Investment Portfolio Returns
June 30,2005
1 Year
Public Safety 9.1%
Benchmark* 6.3%
ASRS 8.5%
COPERS 8.6%
3 Year
10.2%
7.0%
9.2%
9.2%
5 Year
-1.1%
3.0%
2.2%
3.7%
10 Year
8.2%
8.0%
9.4%
nja
*Benchmark 45% S&P 500,45% Lehman Gov/Credit, 10% T-Bill
PSPRS 9
Public Safety vs Benchmark
FYE June 30
25~ i
20
15
10
5
o
_5.J..1t---------------------1
-10.J..It---------------------J
-15
2000 2001 2002 2003 2004 2005
12.31 -16.86 -15.07 6.67 14.97 9.11
5.75 -1.07 -4.13 6.18 8.38 6.32
PSPRS 10
-20-1 t 19961· 1997T 1998 i 1999
511' ",."' I ;. Ti d"r i r
*Benchmark 45% S&P SOD, 45% Lehman Gov/Credit, 10% T-Bill
IliJJ PSPRS I 16.45 I 23.43 I 22.24 I 17.69
• Benchmark* I 13.98 I 17.87 I 17.66 I 11.94
Total Actuarial Assets and Liabilities
June 30, 2005
(thousands)
Total Assets $4/886/963
Total Liabilities $5/951/937
June 30, 2004
(thousands)
Total Assets $4/774/313
Total Liabilities $5/167/333
Funding Ratio 82.1% Funding Ratio 92.4%
PSPRS 11
Book Value vs Market Value
FYE June 30 (millions)
6,000
5,000
4,000
3,000
2,000
1,000
Investment Expense
FYE June 30 (0/0 of Assets)
- - ~----------
0.400% I I
0.350%
0.300%
0.250%
0.200%
0.150%
0.100%
0.050%
0.0000/0 I i I I i I I I I I I
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--*CEM US Universe ,- NASRA Public Fund Survey- Median
-NASRA -Public Fund Survey- Average
*"Comparison of costs to the universe must be interpreted with extreme caution given the breadth of the
universe which encompasses funds with widely varying size and asset mix. Your benchmark cost calculation,
is a much more valuable indicator as to whether you are a low or high cost producer since it adjusts for
differences in fund size and asset mix." Cost Effectiveness Measurement Inc, 2005 pg 12
PSPRS 13
Administrative Expense
FYE June 30 (DID of Assets)
0.120%
0.100%
0.080%
0.060%
0.040%
0.020%
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- NASRA Public Fund Survey· Median - NASRA ·Public Fund Survey· Average
PSPRS 14
Changing Financial Status
@IUU ~~if;\\WJ:ili~:~NS",",l'H'!ifc1tJt\;J!
Actuarial Actuarial
FYE 06/30 Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $ 2,487,953 $ 2,328,276 106.9% $ 2,655,351 114.0%
1997 $ 2,915,173 $ 2,533,435 115.1% $ 3,097,720 122.3%
1998 $ 3,192,627 $ 2,743,998 116.3% $ 3,628,536 132.2%
1999 $ 3,709,251 $ 3,082,202 120.3% $ 4,095,630 132.9%
2000 $ 4,260,168 $ 3,415,157 124.7% $ 4,516,110 132.2%
2001 $ 4,661,941 $ 3,674,758 126.90/0 $ 3,759,164 102.30/0
2002 $ 4,684,386 $ 4,144,211 113.0% $ 3,193,862 77.1 %
2003 $ 4,781,377 $ 4,739,613 100.9% $ 3,364,413 71.0%
2004 $ 4,774,313 $ 5,167,333 92.4% $ 3,741,116 72.4%
2005 $ 4,886,963 $ 5,951,937 82.10/0 $ 4,070,529 68.4%
*Market value does not include future benefit increase reserve
PSPRS 15
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CORP Plan Statistics
Defined Benefit Plan
Active Members
Terminated Vested Members
11,752
130
Retired
Normal
Beneficiaries
Disability
Total Participants
1,339
314
80
CORP
1,733
13,615
2
CORP Plan Statistics
Defined Benefit Plan
As of June 30, 2005
Assets
Funding Ratio
As of June 30, 2004
Assets
Funding Ratio
Actuarial Value
$873 Million
96.4%
Actuarial Value
$834 Million
104.8%
Market Value*
$747 Million
82.5%
Market Value*
$673 Million
84.6%
*Market value does not include Future Benefit Increase Reserve
CORP 3
Employee
contributions
34,589,714
29%
Employer
Contributions
16,291,914
14%
Total Revenue
June 30, 2005
Service Purchase
2,267,921
2%
CORP
Investment Income
66,277,084
55%
4
Total Expenses
June 30, 2005
Refunds
$16,652,638
33%
Insurance
$2,400,849
5%
Transfers
$1,115,311
2%
Suvivor Benefits
$3,871,675
8%
CORP
Admin Exp
$922,183
2%
Disability Benefits
$1,305,434
3%
Normal Retirements
$23,519,992
47%
5
Net Cash Flow
FYE June 30 (thousands)
$25,000 I i
1996 1997 I 1998 I 1999 I 2000 I 2001 I 2002 I 2003 I 2004 2005
$0
$5,000
$10,000
$15,000
$20,000 +1------i
• Net Cash Flows 18,175 20,863 I 22,621 I 23,200 I 18,762 I 13,986 I 3,654 I 912 I 4,996 3,361
EE & ER Contributions less Benefit Payments and Expenses
CORP 6
Asset Allocation
June 30,2005 (at Market)
Bonds
161,755,247
21%
Real Estate
32,953,273
4%
Cash
44,236,811
6%
CORP 7
00
Investment Portfolio Returns
FYE June 30
CORP
Benchmark*
ASRS
COPERS
1 Year
9.2%
6.30/0
8.5%
8.6%
3 Year
10.0%
7.0%
9.2%
9.2%
5 Year
-1.2%
3.0%
2.2%
3.7%
10 Year
8.0%
8.0%
9.4%
n/a
*Benchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% T-Bill
CORP 9
CORP Plan vs Benchmark
FYE June 30
25.00%
-5.00%
O.OOO/o~
5.00%
20.00%
10.00%
15.00%
-15.00%
-10.00%
1996 1997
o CORP 115.30% I 22.74% 121.68% 117.60% 113.22% 1-17.07%1-14.73%1 6.15% 14.77% I 9.23%
• Benchmark* 113.98% 117.87% 117.66% 111.94% 1 5.75% I -1.07% I -4.13% I 6.18% 8.38% I 6.32%
*Benchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% T-Bill
CORP 10
Total Actuarial Assets and Liabilities
96.4%
(in thousands)
$872,981
$906,025
104.8%
Total Assets
r··..·....·....·......·..··..·..·....·..·....J'~·~~ .·3·0~·····2004 .·.·.·.·.·.·.·\
i (in thousands) II
$833,621 I,iI
$795,775 II
I
I Total Liabilities
!
1!I
Funding Ratio
!iI!!
,\
..
[--------J~~~-30;-2005---------j
!!!f ITotal Assets
I:
ITotal Liabilities
iI
!Funding Ratio
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CORP 11
Book Value vs Market Value
FYE June 30 (in thousands)
$900,000
$800,000
$700,000
$600,000
$500,000
$400,000
$300,000
$200,000
$100,000
$0 I 1996 1997
o Book $309,150 $365,414
• Market $347,932 $449,637
1998
$426,352
$571,261
1999
$519,862
$696,231
$588,205
$807,766
CORP
$631,618
$683,192
2002
$646,862
$586,328
2003
$587,318
$622,939
2004
$615,696
$719,235
2005
$662,258
$788,874
12
----
- .--.-----------
Investment Expense
FYE June 30 (% of Assets)
0.4000/0 I i
0.350%
0.300%
0.250%
0.200%
0.150%
0.100%
0.050%
0.0000/0 I ( Iii ( Iii i I
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-CEM US Universe - NASRA Public Fund Survey- Median
- NASRA -Public Fund Survey- Average
"Comparison of costs to the universe must be interpreted with extreme caution given the breadth of the
universe which encompasses funds with Widely varying size and asset mix. Your benchmark cost calculation,
pg 10, is a much more valuable indicator as to whether you are a low or high cost producer since it adjusts
for differences in fund size and asset mix." Cost Effectiveness Measurement Inc, 2005 pg 12
CORP 13
0.140%
0.120%
0.100%
0.080%
0.060%
0.040%
0.020%
0.000%
Administrative Expense
FYE June 30 (% of Assets)
...--/_. /~ -- .----- /' -~'-./ --- --' -
---------
~ ~ ~ : I # # i ~ ~
~ ~ ~ ~ ~ ~ ~ ~ ~ ~
-CORP
-- CEM US Universe
- NASRA Public Fund Survey- Median
- NASRA -Public Fund Survey- Average
CORP 14
Changing Financial Status
Actuarial Actuarial
FYE 06/30 Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $ 319,255 $ 290,518 109.9% $ 347,028 119.5%
1997 $ 393,904 $ 355,950 110.8% $ 448,281 126.1%
1998 $ 484,956 $ 410,531 118.1% $ 555,751 135.4%
1999 $ 592,152 $ 443,676 133.5% $ 653,777 147.4%
2000 $ 704,991 $ 501,323 140.6% $ 747,981 149.2%
2001 $ 776,177 $ 554,387 140.0% $ 637,372 115.0%
2002 $ 782,446 $ 632,238 123.8% $ 551,876 87.3%
2003 $ 811,791 $ 709,298 114.4% $ 592,230 83.5%
2004 $ 833,621 $ 795,775 104.8% $ 673,322 84.6%
2005 $ 872,981 $ 906,025 96.4% $ 747,458 82.5%
*Market value does not include future benefit increase reserve
CORP 15
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E()RP Statistics
Defined Benefit Plan -Jun.e301 2005
Active Members 781
Terminated Vested Members 87
Retired
Members
Beneficiaries
Disability
Total Participant
600
18
151
EORP
769
1,637
2
EORP Statistics
Defined Benefit Plan
As of June 30, 2005
Assets
Funding Ratio
Asof.lune30,2004
Assets
Funding Ratio
Actuarial Value
$344,604
95.5%
Actuarial Value
$343,376
104.4%
Market Value*
$287,882
79.8%
Market Value*
$268,214
81.5 %
*Marketvalue does notinclude Future Benefiflncrease Reserve
EORP 3
-rota I Revenue
June 30, 2005
Employee
contributions
$3,617,383
9%
Court Fees
3,792,729
9%
Employer
Contributions
3,304,513
8%
Service Purchase
3,646,744
9%
EORP 4
Total Expenses
June 30, 2005
Admin Expense
$131,655
0.5%
Transfers
$246,091
0.9%
Suvivor Benefits
$3,671,914
14.0%
EORP
Disability Benefits
$1,073,453
4.1%
5
I\JetCash F.low
FYEJune30 (in thousands)
$0
($2,000)
($4,000)
($6,000)
($8,000)
($10,000)
($12,000)
($14,000) .
1996 1997 I 1998 I 1999 I 2000 12001 L 2002 I 2003· '.2004 I 2005
��� Net Cash Flows I -2,413 I -2,496 I -3,363 I -5,262 I -4,215 \-9,0251-11,907 1-12,333\ ..12,957 I -11,845
EE &ER Contributions less Benefits Payments and Expenses
EORP 6
Asset Allocation
June 30,2005 at Market
Real Estate
13,192,646
4%
Bonds
64,673,263
21%
EORP
Cash
15,995,477
5%
7
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Investment Portfolio Returns
as of FYE June 30, 2005
EORP
Benchmark*
ASRS
COPERS
1 Year
9.6°10
6.3°/0
8.5°/0
8.6°/0
3 Year
10.4°/0
7.0°/0
9.2°/0
9.2°/0
5 Year
-1.1°/0
3.0°/0
2.2°/0
3.7°/0
10 Year
8.4°/0
8.0°/0
9.4°/0
n/a
*Benchmark 45% S&P500, 45%Lehman Gov/Credit, lOO/oT-Bill
EORP 9
Elected Official vs Benchmark
FYE June 30
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
-20.00% .
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
[] EORP 117.70% 124.59% 121.26% 117.51% 113.20% 1-16.96%1-15.36%1 6.69%
• Benchmark* 113.98% 117.87% 117.66% 111.94% I 5.75% 1-1.07% 1 -4.13% I 6.18%
*Benchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% T-Bill
EORP
15.02% 19.56%
8.38%1 6.32%
10
'-()taliActuiarialAssetsancl.. L.ia bi lities
June 30, 2005
(in thousands)
June 30, 2004
(in thousands)
Funding Ratio
ITotal Assets $344,604 I ITotal Assets $343,376
ITotal Liabilities $360,75811 Total Liabilities $328,921
I I
95.5% IFunding Ratio 104.4% I
, I I : \ .:
EORP 11
Baal< iVaiue vs !VIarl<etVal.ue
FYEJune 30 (in thousands)
$450,000
$400,000
$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
$0 .
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Q Book I $161,523 $179,813 $209,248 $258,050 $285,205 $293,478 $288,377 $247,793 $246,308 $253,314
.Marketl $211,745 $260,314 $311,329 $359,492 $402,244 $326,159 $265,567 $269,611 $295,932 $311,494
EORP 12
- ~--------
Investment Expense
FYE June 30 (DID of Assets)
0.4000/0 I I
0.3500/0
0.3000/0
0.2500/0
0.2000/0
0.1500/0
0.1000/0
0.0500/0
0.0000/0 I I Iii iii I I I
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~t:o
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-Elected Officials -CEM Benchmark Calculation
-CEM US Universe -- NASRA Public Fund Survey- Median
-NASRA -Public Fund Survey- Average
"Comparison of costs to the. universe must be. interpreted with extreme caution given the breadth of the universe which
encompasses funds with widely varying size and asset mix. Your benchmark cost calculation, pg 10, is a much more
valuable indicator as to whether you are a<low or high cost producer Since it adjusts for differences in fund size and asset
mix.". Cost Effectiveness Measuremenf Inc, 2005pg12
EORP 13
Aclrninistrative Expense
F)'E>June 30 (°10 of Assets)
0.:1.20% I I
0.:1.00% I ;/ , I
0.080% I ~ ==" I
0.060% •I I
0.020% .-1 ~ I
0.040% . I ~ I
0.000% I I I I I I I i I I I
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--Elected Officials -CEM US Universe
- NASRA Public Fund Survey- Median -NASRA-Public Fund Survey-Average
EORP 14
ChangingFinanciaI Status (in thousands)
Actuarial Actuarial
FYE 06/30 Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $ 181,754 $ 158,126 114.90/0 $ 210,397 133.1%
1997 $ 214,035 $ 169,593 126.2% $ 256,524 151.3%
1998 $ 241,884 $ 199,662 121.10/0 $ 281,567 141.00/0
1999 $ 283,337 $ 227,100 124.80/0 $ 319,010 140.5%
2000 $ 329,777 $ 253,478 130.1% $ 355,335 140.2%
2001 $ 355,768 $ 250,987 141.7% $ 291,723 116.20/0
2002 $ 351,349 $ 279,947 125.5% $ 242,167 86.50/0
2003 $ 353,463 $ 297,892 118.7% $ 251,019 84.3%
2004 $ 343,376 $ 328,921 104.4% $ 268,214 81.5%
2005 $ 344,604 $ 360,758 95.5% $ 287,882 79.8%
*Market value does not include future benefit increase reserve
EORP 15
PSPRS FUNDING STATUS IMPROVE:MENT OPTIONS
AND
CONSTRAINTS
Challenge
Despite the fact that the three Retirement Plans that PSPRS administers have earned
above market returns over the past two fiscal years, their financial status has deteriorated
significantly since June 30, 2001 (FY'Ol). Unlike the situation at June 30, 2003 (FY'03)
in the case of the Public Safety Personnel Retirement System (PSPRS) Plan, and at June
30,2004 (FY'04) in the case of the Corrections Officer Retirement Plan (CORP) and the
Elected Officials Retirement Plan (EORP), all three Plans now have funding ratios of less
than 100% as ofthe end ofFY'05.
In the case of PSPRS, its funding ratio at the end of FY'Ol was 126.9%. By the end of
FY'04, the ratio had declined to 92.4%. By the end of FY'05, the funding ratio had
slipped to 82.1%.
In the case of CORP and EORP, their FY'Ol funding ratios were 140% and
141.7%respectively; but by the end of FY'05, their ratios had declined to 96.4%, in the
case of CORP, and 95.5%, in the case of EORP -- ratios indicative of still well-funded
plans but ones with new asset deficiencies.
Of course, as the three Plans have moved from positions of asset surplus to positions of
asset deficiency, the required employer contributions have increased markedly. While the
Plans held excess assets, those excess assets, expressed as a level percent of payroll and
amortized over twenty year rolling periods, had the effect of keeping employer
contribution rates abnormally low, relative to employer "normal cost" (i.e., the employer
share of the cost, expressed as a level percent of payroll, of the addition to liability that
resulted from the covered group's service credit accruing in any given year). Now with
unfunded liabilities existing in all three Plans, the cost of amortizing those unfunded
liabilities, expressed as a level percent of payroll and amortized over twenty year rolling
periods, must be added to what would otherwise be the employer normal cost, thus
inflating the employer contribution rates to higher levels.
Options and Constraints
Page Two
In the case of PSPRS and based on that System's financial status at June 30, 2001, the
FY'03 aggregate employer contribution rate was only 4.46%. However, given the PSPRS
financial results as of the end of FY'05, the aggregate employer contribution rate
projected for FY'07 is up to 17.1%. By comparison, the PSPRS employee contribution
rate, which is set by statute, is only 7.65%
For the CORP, the FY'03 aggregate employer contribution rate was only 2.14%, based
on the Plan's FY'01 financial results. Now, based on the Plan's FY'05 financial results,
the aggregate employer contribution rate projected for FY'07 is 7.06% -- a rate that is
lesstba.nthe statlltory8.5%employeerate,but stillone that is 410% of what it was in
~~~~~FY=-'03. . . . .
Finally, for the EaRP and based on its FY'01 financial results, the FY'03 employer
contribution rate was 7.55%. Now, based on the Plan's FY'05 financial results, the
projected FY'07 employer rate will be 24.27%.
Unfortunately, and even despite the good investment performance of the past two years,
the near-term expectation is for further erosion in the funding ratios of all three Plans.
The challenge that is posed, given the present and projected situation is simple: Without
impairing the fiscal integrity of the Plans,what can be done to ameliorate or reduce what
will otherwise be relatively large required employer contribution rate increases in FY'07
- increases that are certain to present budgetary problems for the three Plans'
participating employers at the State, county and municipal levels?
Contributing Factors
The principal factors that have, in the aggregate, contributed to the erosion in the funding
ratios of the Plans and to the significant rise in the employer contribution rates are as .
follows. First, there is the very significant loss in asset values attributable to the 2001
through 2002 financial market contractions, the effects of which are not yet fully
reflected in the Plans' actuarial value of assets. Those asset values are determined
annually based on a rolling seven year average.
The second factor relates to PSPRS' having to reflect actuarially the investment
environment in which the Plans are operating. Clearly, the current investment
environment is not as positive or robust as that which prevailed throughout the last half of
the 1990's. In recognition of that reality, the System has begun to reduce its former 9%
actuarially assumed rate of return in one quarter of one percent increments. For FY'05,
the assumed rate was 8.75%. During the current FY'06, the rate is 8.5%. The System's
actuary has said that everyone quarter of one percent reduction in the actuarial rate of
return assumption results in a one and one-half percent increase in the employer
contribution rate requirement. Although the System's Fund Manager will likely pause to
Options and Constraints
Page Three
assess whether the System's latest rate of return assumption reasonably reflects the true
rate of return experience of the Plans, it is possible that even further reductions in the
assumed rate may be necessary in the future.
A third factor that has the effect of suppressing the Plans' actuarial value of assets and
their funding ratios is the way in which the Plans are statutorily required to pre-fund
annual post-retirement benefit adjustments. Under current law, either one-half (in the
case of PSPRS and CORP) or all (in the case of EORP) of the Plans excess investment
returns (i.e., investment returns in excess of 9%) must be allocated to each Plan's Future
Benefits Inc:rease R.eserve. A.s sllch,theassets in t~ese reserves ($537.5 million for
-----.·"'p.-nSpRS,n $zn-:zl: ~nill.lionfb.r -roRP~aIrd--$-23~liori4:{)r-EeR-p--=a~~0f--FY-'-O§j=and=th€-----
earnings thereon are not included in the calculation of the Plans' actuarial value of assets,
and that, in turn, negatively impacts the Plans' funding ratios and their employer
contribution rates. Furthermore, some have argued that excess earnings should never be
siphoned off or allocated to fund future, additional benefits, for, to remain actuarially
sound, the Plans need to retain excess earnings merely to offset the poor investment
returns the Plans are certain to experience from time-to-time.
The fourth factor relates to the value the System assigns to the Plans' Alternative
Investments Asset Class. By custom and practice these investments (i.e., primarily real
estate investments along with a relatively small exposure to private equity) are carried at
cost. However, since these investments currently have net market value significantly in
excess of cost, the Plans' actuarial value of assets is understated. This, too, causes the
Plans' funding ratios to be understated and the required employer contributions to be
overstated.
The fifth factor comprises the benefit improvements made in recent years that have added
significantly to Plan liabilities. The major addition was the creation of the Deferred
Retirement Option Plan (DROP) for the PSPRS Plan. Although it was created as a "pilot"
program for the period from 2001 to 2006, the DROP was made permanent in 2002. The
original twenty-five year service requirement for DROP participation eligibility was
reduced to twenty years in 2001. Other legislated changes that took effect in 2002 were
the increase in the PSPRS survivor benefit from 75% to 80%, the permanent 2% tax
equity increase in pensions for employees hired before 1989, and an increase in the duty
death spousal benefit from 50% to 100% of average compensation. Additionally, in 2001,
the post-retirement health insurance subsidy amounts were significantly increased.
Finally, an enhanced refund provision was enacted several years earlier.
The final factor relates to certain economic and demographic actuarial assumptions that
have had the net effect of enhancing the Plans' projected rates of liability growth.
Options and Constraints
Page Four
Constraints
There are a number of constraints that will limit the options available to the PSPRS Fund
Manager and to policymakers for enhancing the financial condition of the Plans and
reducing what will otherwise be the required employer contribution requirements for
FY'07. These include:
A. The Arizona Constitution's prohibition against diminishment of
contractual pension rights and the Arizona case law (beginning with
the Yeaz~ny. CopillS case) related to this issue. (See Attachment A);
B. The Existing unfunded liabilities of the retirement Plans; and
C. Political Factors.
A line of Arizona state court decisions, beginning with the 1965 case of Yeazell v.
Copins, stand for the proposition that pension benefits are a matter of contractual right
that cannot be diminished or impaired once vested. ill addition, Article ~IX, Section 1,
Paragraph C of the 1998 version of the State's Constitution clearly stat~s that "....
public retirement system benefits shall not be diminished or impaired." .
Given the Arizona case law and the State Constitution's prohibition against pension
benefit diminishment, it should be clear that, in general, the existing structures of benefits
probably cannot be reduced for current system beneficiaries or participants.
Options to Reduce the Rate of Plan Liability Growth, Increase Plan
ContributionslIncome and/or Assets and Increase the rate of Asset Growth
Although there are a variety of options available to the PSPRS Fund Manager and to
policymakers to enhance the financial condition of the System's Plans and thereby reduce
what will otherwise be the employer contributions required in FY'07, based on FY'05
results for the Plans, many of them have constitutional and/or political or other problems
that impair their viability either partially or completely. Here is a review of the most
obvious ones. These options would either reduce the rate of liability growth, or increase
Plan contributions/income and/or assets or increase the rate of Plan asset growth.
A. Reducing the Rate of Future Liability Growth
1. Creating a Second Tier Defined Benefit Plan (DB) for New Hires
Without violating the pension protection clause of the Arizona State Constitution
(i.e., Art. XXIX, Sec. 1, Paragraph C), new, simplified, and significantly less
Options and Constraints
Page Five
generous defined benefit (or cash balance) plans could be designed to cover
newly-hired participants in the three Plans that PSPRS administers. This option
would slow the rate of growth in liabilities in the distant future; it would,
however, do little to improve the financial status of the Plans in the near-term and
ease the employer contribution burden. (There is some uncertainty as to whether
future benefits for current Plan participants who have not yet "vested" could be
reduced without violating the Constitution due to the Court of Appeals' decision
______~=";,;.in=~t="""h""=e=c=£ls"e()f:F'uIldM~Illlgevr .9tyofP~oenixPolice Department Public Safety
PersonnerRetrrement System Boarc1j~)I~"-"-"-""-~~"-"---~~-==:====-==~==--~==~====
The process for developing/designing a new pension plan for new hires could be
undertaken as follows: First, the criteria or objectives for the new plans would be
specified. For example, the criteria/objectives might call for plans that are,
relative to the existing Plans, less expensive and have, relative to the current
Plans, later normal retirement ages, later early retirement ages, longer vesting
requirements, benefit formulas with lower accrual rates, periods longer than three
years for averaging final salary, less generous survivor benefit formulas, less
generous disability benefit formulas and more stringent eligibility requirements
and a post-retirement cost-of-living adjustment that is tied to the movements of
the Consumer Price Index (C.P.i) and capped at some limit (for example 3%).
Another factor to be considered is whether social security coverage is or is not
available. Social security coverage, or the absence thereof, would have
consequences for both plan design and cost.
Second, once the criteria/objectives are specified, a pension plan consulting
andlor actuarial firm could be asked to develop the specifics to implement and
achieve the specified criteria/objectives, taking into account differences among
the new hire employee groups who would be served by the new plans.
Third, once the designs for the plans are complete and in order to know the extent
of the future savings in pension costs, actuaries would be asked to project the cost
for the new plans and compare them to the projected costs for the current plans if
they were to continue to apply to the new hire groups.
Finally, the legislation to implement the new plans would have to be closely
scrutinized so as to avoid anomalous and unintended consequences (i.e., the
availability of certain benefits for persons for whom they were never intended).
Options and Constraints
Page Six
But the political obstacles to the option of designing/implementing new, less
generous and less expensive DB plans for new hires should be obvious. This
option is certain to encounter intense and unified opposition from public
employees, retirees and their organizational representatives, since it would appear
that new hires are being forced to pay disproportionately more for less generous
future benefits. Additionally, public employee organizations would be expected
to oppose any "two tier" program on the grounds that public employees should
have the benefit of equal pay and equal benefits for equal work, regardless of their
date of hire. Finally, implementation of such alternative plans would counter the
current statutorily expressed aims of the Plans, which is to provide a uniformity of
------,b'-e~n~e-r<h..-ts~forall public safety petmnnet;-c-orrectioi"IfOfficers-arid--eleeted--offieialsc--.------·
2. Mandating Defined Contribution (DC) Plan Coverage for Newly Hired
Employees.
"Closing" the existing DB plans and mandating the use of defined contribution
(DC) plans for newly hired employees is an option used extensively in the private
sector and, more recently, in some states for public employee groups. However,
this option is probably not a realistic option for newly hired employees in Arizona
for the PSPRS-administered Plans. Here is why.
First, if the new DC Plans are to provide future benefits that are reasonably
comparable to those provided by the current DB Plans, there would likely be no
net savings to the employers, even in the long term. Moreover, given the costs
associated with DC Plan administration, there could actually be an increase in
long-term employer costs.
Second, since two of the three Plans that PSPRS administers are for the benefit of
defined public safety groups and given those groups especial need for disability
protection, that coverage, which tends to be costly, would have to be added to the
coverage otherwise provided by the DC Plans.
Third, although DC Plans less generous than the current DB Plans could be
designed and implemented for new hires, and although in the long-term
employers could reduce their pension costs by pursuing this option, in the near
term employers would see little, if any, pension contribution relief because: (1)
they would be obligated to make employer contributions to the new DC Plans,
even while they would remain solely responsible for the employer share of normal
cost for the closed DB Plans and for the cost of amortizing the existing and
growing unfunded liabilities of those closed DB Plans (especially as employee
contributions diminish over time); and (2) they would have to fund all, or part of,
the cost of disability protection, at least for their public safety employees. (See
Attachment B)
Options and Constraints
Page Seven
3. Reducing the Rate of Growth in Liabilities By Changing Actuarial
Assumptions to More Closely Reflect Emerging Benefits and Benefit
Promises
A. The Salary Growth Assumption
ForFY"'Q6'tl1esalary g~o\Vth assufi1ptiol1for PSPRS is 6%; the actuarialassumed
-------"=:ra=t=e--=ocrf--=r=et'-ccu=rn~~~l~s~s_:5%~esa.i~groWtl1as5umptiOITlis-edlo-be-_6~5o/d_wheil-the:-----
rate of return assumption was 9%. However, now that the return assumption has
been reduced, the salary growth assumption has been reduced along with it in
order to maintain a 2.5% "spread"between these two related percentages.
The System's actuary should be asked to review both the salary growth
assumption and the 2.5% spread between that assumption and the rate of return
assumption. It may be that a lower salary growth assumption is warranted based
on the actual salary growth experience of the covered group and it may also be
appropriate and acceptable to widen somewhat the spread between the salary
growth assumption and the rate of return assumption.
If it is found that the salary growth assumption could be lowered to more
accurately reflect the actual salary growth experience of the covered group and
the spread between the salary assumption and the rate of return assumption could
be widened, while still remaining within what is generally acceptable and prudent
actuarial practice, then the combined effect of these changes would serve to
reduce the rate of growth in liabilities, improve the funding ratio of the PSPRS
Plans and reduce the FY'07 employer contribution rates from the currently
scheduled levels (i.e., the levels based on the Plans' FY'05 results). (See
Attachment C) If any changes are warranted, the Fund Manager can make the
decisions in this regard, based on the actuary's recommendations.
B. Demographic Assumptions
The System's demographic assumptions, such as, for example, those for rates of
retirement and DROP, participant "turnover," group mortality experience and
incidence of disability, should be reviewed for the purpose of determining
whether actual group experience continues to be consistent with the assumptions
that are in place for each of the Plans. If inconsistencies are found, changes may
need to be made so that the assumptions do reflect actual group experience. The
net effect of such changes may result in a lessening of the rate of growth in
Options and Constraints
Page Eight
System liability, and, if so, an improvement in the System's funding ratio and a
concomitant reduction in the projected employer contribution requirements.
4. Actuarial Methodology
The PSPRS currently uses the entry age normal cost actuarial method for
allocating System liabilities between the covered group's past service (i.e.,
actuarial accrued liability) and future service (i.e., normal cost). However, there
are other accepted actuarial methodologies that produce liability allocation
patterns that differ from those obtained with the entry age normal cost method.
"---"-----.one suell alternative metliod~orexample,- is----tlTeuprojected=tiiiiFCiedit=cost-----
method.
The System's actuary should determine whether a change from the entry age
normal cost method to some other widely accepted actuarial method could serve
to reduce the PSPRS unfunded actuarial accrued liability and increase normal cost
but still effect a net improvement in the System's current financial status. (See
Attachment D) If such a change could effect a net improvement and if such net
improvement were found to be significant, then the PSPRS Fund Manager could
consider a change in the System's actuarial methodology.
5. Changing the PSPRS Amortization Period
Currently, the PSPRS Plans use a twenty year amortization period to amortize
unfunded accrued liabilities or excess assets. This could be changed to a thirty
year (or, perhaps, even a forty year) amortization period and still the System's
Plans would be within acceptable actuarial practice. The System's actuary has
been asked to determine the effect on the funding ratios of the System's Plans and
on the projected FY'07 employer contribution rates if the twenty year period were
extended to thirty and forty years. (See Attachment E) Of course, given that
current law allows the PSPRS Plans' participants to retire with only twenty years
of service, an extension of the amortization period beyond twenty years will have
the effect of amortizing unfunded liabilities beyond the statutorily expected
employment career.
6. Limiting the Amount of Compensation on Which Contributions Are Assessed
Another option that could help limit or slow the rate of growth in liability would
be to limit prospectively (i.e. with respect to future service, not past service) the
amount of compensation that is subject to employee pension contributions (as, for
example, a maximum of $75 thousand per year. (See Attachment F) This would
limit the amount of the average high-three-consecutive-years of compensation and
thus result in lower pension benefits than would otherwise be the case for
Options and Constraints
Page Nine
participants who received compensation in excess of the maximum. Those
participants would benefit by having their excess compensation (Le. the amount
that exceeds the maximum) unreduced by pension contributions; however, their
high three year average would be reduced (relative to what would otherwise be
the case) and so would their pension benefits.
However, any change such as the one described above may be challenged on
constitutional grounds and would likely be resisted by the public employee
groups. Of course, such a change could be made for new hires participating in
second tier DB plans.a.lthougll thatto() wOllldencouIlt~rp()litic~ 0IJPosition.
A variation of this option could take the form of a percentage limitation on the
amount of compensation increase that would be subject to pension contributions
and taken into account in calculating the average high-three-consecutive-years
compensation at the time of retirement. However, this too would run into
constitutional challenge and strenuous opposition from the public employee
constituent groups because a change such as this would ultimately reduce pension
benefits of current participants relative to what they would otherwise be under
current statutes.
7. Reducing the Rate of Interest Credited to PSPRS Deferred Retirement Option
Plan (DROP) Accounts
Under paragraph e(2) of Sec. 38-844.05, a PSPRS DROP participant's account is
credited monthly with interest at the assumed rate of return established by the
PSPRS Fund Manager. It might be possible to amend this provision to indicate
that, if, during the DROP participation period, the Fund Manager reduces the
assumed rate of return, the DROP participant's account would be credited with
the lower percentage prospectively from the effective date of the new and lower
rate. This would have the effect of reducing the DROP lump sum amounts
otherwise payable and thus reduce PSPRS liability somewhat, relative to what it
would otherwise be.
However, in the case of current DROP participants, such a change would be
challenged on the grounds that it constitutes an unconstitutional diminishment of
benefits and amounts to an after-the-fact and detrimental change of the rules on
the basis of which the DROP participant made an irrevocable election to
participate in the program in the first place. Such a proposed change would be
certain to encounter strong political resistance by the public employee
constituency groups.
Whether such a change would survive a challenge on constitutional grounds if it
were applied to current PSPRS Plan participants who have not yet elected to
Options and Constraints
Page Ten
participate in DROP is uncertain (because of the Fund Manager v. City of
Phoenix case). However, such a change would likely encounter opposition from
the public employee constituency groups.
B. Increasing System Revenue and/or Assets
1. Earmarking or Dedicating a Contingent Funding Source
The State could earmark or dedicate a new contingent funding source that would
]2rovide, in effect, asubsidy,tooff~~t'what 0th.erV\Tise. \Vould be the contrilmtions
-required from the employer enfmestliifare-coveretl--by-th.ethren>Si>R-S-Plans:-=-.··-------.-:..­For
example, the revenue from a fractional percentage increase in the State sales
tax could be dedicated for this purpose. Additionally, such a revenue subsidy
could be made contingent on the funding ratio level of the Plans. In other words,
the revenue stream would only begin to flow, once a Plan's funding ratio declined
below a statutorily prescribed level (as, for example, 85%). However, statewide
tax increases, even if designed to reduce what would otherwise be tax burdens at
the local level, are rarely popular with taxpayers or lawmakers. Therefore, this
option is probably not politically possible.
In the alternative, it might be possible to generate increased income for the Plans
by imposing new statewide fees that are appropriate and in some way related to
the services that are provided by some or all of the covered participants of the
PSPRS Plans. At a minimum, existing fees (as, for example, state filing fees that
generate some income for the EORP) could be increased; this would be of benefit
to at least some participating employers.
2. Increasing the Actuarial Interest Rate Assumption
Theoretically, the actuarial rate of return assumption for the PSPRS Plans could
be restored to 9% from the current rate of 8.5% on the grounds that, over the last
two fiscal years (i.e., FY'04 and FY'05) the actual rates of return for the Plans
were in excess of 9%. This would have the effect of lowering the state's future
contribution requirements.
However, since actuarial assumptions should reflect the System's longer-term
experience, it would be inappropriate to restore the assumption to 9% at this time,
based only on the experience of the last two fiscal years. Despite two years'
worth· of better than expected returns, the preceding three fiscal years were
marked by rates of return that were below expectations. In addition, the financial
markets have not been generating the kind of routinely robust returns that
characterized them during the last half of the 1990's.
Options and Constraints
Page Eleven
At most, it might be appropriate for the PSPRS Fund Manager to maintain the
current (FY'06) 8.5% actuarial rate of return assumption and postpone any further
one quarter of one percent annual reductions until the System has acquired more
time to experience the level of returns likely to be generated in the post-200l
through 2002 financial market environment.
3. Increasing Employee Contribution Rates
It could be argued that employees participating in at least two of the three PSPRS
__~ ~~P=l=an=:;-s-;:ar=-:e~not currently cOlltri1:>lltingtlleir fair shar~ of the financial support that is
needed. In the case ortnePSPR~Pian, rlfe=sfatutory=empIOyee=rate1s~6iil~65%;---~--~-~-~----~ ----
which is less than one-half of the Plan's FY'05 normal cost of 18.36%. It is also
much less than the FY'07 aggregate employer contribution rate of 17.12%, which
is based on the Plan's FY'05 results. In the case of the EaRP, the statutory
employee rate is 7.0%; that is less than one quarter of the Plan's FY'05 normal
cost of 29.57% and less than one-third of the FY'07 employer contribution rate,
which is based on the Plan's FY'05 results.
In the case of the CORP, however, the employee-employer contribution rate
distribution is significantly different from those in PSPRS and EaRP. The CORP
statutory employeerate is 8.5%, which is more than one-half the Plan's FY'05
normal cost of 15.03%. It is also more than the FY'07 aggregate employer
contribution rate, which is only 7.06%. Nevertheless, the currently scheduled
CORP FY'07 employer contribution rate is over 400% greater than what it was in
CORP FY'03 (i.e., 1.71 %).
The System's actuary has calculated that everyone percent increase in the
employee contribution rate would increase the funding ratio by %, in the case
of PSPRS, %, the case of the EaRP, and %, in the case of the CORP (See
Attachment G). Concomitantly, everyone percent increase in the employee
contribution rate would decrease the FY'07 employer rate by percent. It is
unclear whether a challenge on constitutional grounds to an employee
contribution rate increase would probably not be successful. Even if an employee
rate increase is constitutionally authorized, however, an increase in rates for the
Plans' participants would likely be opposed by the public employee groups and
the organizations that represent them. Participants will argue that they will
receive no additional "value" (i.e. no improvement in benefits) for their increased
contributions and they will also argue--and correctly--that when times were good
~ and the Plans had excess assets, those excess assets served to subsidize the
employers, whose contribution rates were abnormally understated. The employees
did not benefit at all in this regard, except to the extent that the buildup of excess
assets strengthened the Plans as a whole. On the other hand, given how low
employee contribution rates are, especially in the case of PSPRS and the EaRP,
---------
Options and Constraints
Page Twelve
relative to the FY'05 nonnal cost percentages for the Plans (which are the best
indicator of the worth or value of the Plans' benefit structures), the constituent
employee groups and their representative organizations might be willing to accept
additional employee contributions to remain actuarially sound or because such
increased contributions are coupled with some perceived improvement in the mix.
of the benefits of the Plans (See below for further discussion).
In the case of the CORP, the implementation of a DROP, authorized by statute
and low in cost (if this is possible), might be sufficient to obtain participant
- willingness to. accept a _cO!J.IDbutioll rate i llcrease.However, _tilis would require
participant organization support, SInce It woulQ necessarUTentaiFa=-cliarige=in---tlie-:~----------- --­CORP
statutes.
4. Assess Contributions with respect to Compensation Paid to PSPRS DROP
Participants
Under Subsec. A of Sec. 38-844.06, neither employee nor employer contributions
are assessed with respect to compensation paid to DROP participants while they
remain employed but are participating in the program for which they made an
irrevocable election. Certainly a statutory imposition of an employee contribution
requirement could be made in the case of newly hired employees. Less certain is
whether such a change would survive a constitutional challenge if it were applied
to current PSPRS Plan participants who have not yet elected DROP. But with
respect to current DROP participants, the imposition of an employee contribution
requirement would not likely survive a constitutional challenge; moreover, such a
change would be contested on contract grounds, since it would amount to an after­the-
fact changing of the rules on the basis of which the DROP election was made
and since the current DROP participants would earn no improvement in their
pension benefit amounts.
Less clear are the consequences for PSPRS covered employers, if they were
required to contribute to the Plan, based on the compensation they pay to DROP
participants. Clearly, in the case of employers with current DROP participants,
they would be assessed contributions on 100% of payroll paid to PSPRS
participants. The Plan would experience an increase in contribution income,
which, in turn, would result in some improvement in the Plan's funding ratio and
some diminishment in the aggregate employer contribution rate. However,
whether an individual employer would experience a net increase or decrease in
total dollar PSPRS contributions would probably vary depending on the size of
each employer's DROP participant group and the amount of compensation paid to
that group. The System's actuary could provide the projections necessary to
define the consequences of this possible policy change. (See Attachment H) In
Options and Constraints
Page Thirteen
addition, we would need to research whether the change is permissible under the
Internal Revenue Code.
5. Increase the Employer Contribution Minimum Rate
Currently, the minimum employer contribution requirement as set by statute for
the three PSPRS-administered Plans is 5%. Since the aggregate employer rate
scheduled for FY'07 is well above this minimum 5% floor, legislation could be
enacted to increase the contribution to a higher percentage (perhaps 6% in the
case of CORP, 8%in the case of PSl)RS_and10% in the case of EORP).
While this would not produce any additionail.~coniefbrfijese-two:::::Plans=tn.=tfiec-- ---------------------------
near term, it might have a beneficial effect on Plan revenues in the future,
assuming aggregate employer contribution rates decline from currently projected
levels.
6. Recapture Benefits Through the State Income Tax and Earmark the Revenue
for the PSPRS Plans
In the early 1980's, a special comrmSSlOn on social security under the
chairmanship of Allan Greenspan developed a set of proposals that were designed
to rescue social security's OASDI programs from impending insolvency. One of
the elements of that set of proposals (all of which were enacted by the U.S.
Congress) required the inclusion of a portion of social security payments in gross
income for federal income tax purposes. (Prior to that, social security payments
had been tax exempt.) The additional federal revenue was then earmarked for
payment back into the social security trust funds.
Here in Arizona, paragraph 2b of Sec. 43-1022 of the state income tax laws could
be changed to eliminate or reduce the (up to) $2,500 subtraction allowed for
Plans' pension payments in the calculation of adjusted gross income, with the
revenues raised thereby earmarked for the Plans that paid the benefits. In effect,
this would amount to a back door (i.e., via the state income tax structure) benefits
recapture program. However, any such tax law change would certainly be
resisted legislatively by the public employee groups and likely be challenged on
constitutional grounds as a back door diminishment of benefits.
More broadly, all pension payments and other forms of retirement income (both
public and private) could be made subject to the state income tax without any
subtraction allowed in calculating adjusted gross income, with the revenue
earmarked back to the state public retirement systems in proportion to their
respective unfunded liabilities. However, this would certainly be perceived as a
Options and Constraints
Page Fourteen
tax increase and that would be strongly resisted by the state's retirees and their
representative organizations.
7. Marking to Market PSPRS Plan Real Estate and Other Alternative
Investments
It has been the long-standing practice at PSPRS to carry the real estate and other
alternative investments of the three Plans at cost until such time as income is
realized. While the percentage of total Plan assets represented by such
iny~stments· varies. from time-to-:time,. they pmlJlll:>ly~()nsgtuteabout five percent
of each Plan's assets on average. ~ .... _._. - . - ------
Two questions are therefore presented. First, could such investments be marked to
market in some way or, at least, could values more realistic than cost be assigned
and up-dated periodically? Second, if more realistic values could be determined
for this class of investments, would that significantly increase the Plans' actuarial
value of assets and their respective funding ratios and thus reduce what would
otherwise be the projected FY'07 employer contribution requirement? The
PSPRS investment staff will provide answers to these questions. (See Attachment
I)
8. Re-examine the Treatment of the Assets in the PSPRS Plans' Future Benefits
Increase Reserves
Under current law, all three PSPRS-administered plans provide for post­retirement
adjustments. However, actual adjustments are contingent on each
Plan's having assets in its Future Benefits Increase Reserve sufficient to cover the
cost of funding each year's increase. The methodology for calculating the amount­of
the increase is specified in each Plan's statutes, but in no event can the increase
exceed 4% per year. (As a practical matter, given the significant accumulation of
excess assets in each Plan's Reserve, the recent increases have been 4% annually.)
The Reserve assets are accumulated as follows: With respect to PSPRS and the
CORP, one-half of the asset value represented by each Plan's rate of return in
excess of 9% is allocated to each Plan's Reserve (along with any subsequent
return generated on the Reserve account balance). In the case of EaRP, all the
asset value represented by the Plan's rate of return in excess of 9% is allocated to
the Plan's Reserve.
None of the assets contained in the three Reserves are counted in the calculation
of the Plan's actuarial value of assets. In effect, for the calculation of the Plan's
Options and Constraints
Page Fifteen
funding ratio (and the required employer contribution that is determined based on
the Plan's funding status), these assets are treated as if they do not exist.
On the other hand, because the annual post-retirement adjustments are fully
funded whenever they occur, the actuary does not factor into the calculation of the
Plan's future liability, any amount for future benefit increases, since they
represent only a contingent liability and, whenever they occur, they are fully
funding.
-Nevertheless,historically,giveneaGh_flaI1'_s_:ra-1~s_Qt!~tllill, the acclllllulation of
assets to fund post-retirement adjustments hasoeen moretlian--wlf:n=-~lrifs=beerrri---- --~~
needed. That explains the build-up in the amounts in the Plans' respective
Reserves.
The issue presented for actuarial analysis and for policy decision-making is this:
What would be the effect of a change in the law that folded the Reserve assets
into the calculation of each Plan's actuarial value of assets while avoiding any
possible constitutionally impermissible impairment or diminishment of post­retirement
benefit adjustments for current beneficiaries and participants? First, of
course, if the Reserve assets were no longer segregated, the actuary would have to
factor in an annual addition to each Plan's liability in an amount sufficient to
provide for an annual increase, since the post-retirement adjustments would cease
to be contingent on the availability of Reserve assets. Second, the post-retirement
adjustment methodologies would have to remain unchanged, except with respect
to the annual increase percentage limit. That would have to be lowered to avoid a
net increase in the liabilities of the Plans. (In effect, Plan beneficiaries and
participants would be trading a contingent benefit increase for an annual,
constitutionally guaranteed benefit increase, albeit one the has a percentage
maximum lower than the current 4%.)
But what would be the effect on the current financial status of each Plan? We
know that, in the past, the accumulated Reserve assets have been more than
sufficient to finance the adjustments that have occurred. But now, the Plans are
assuming future rates of return that are less than the 9% threshold that must be
reached in order for there to be an allocation of new assets to the Reserves. If the
9% threshold were reduced to whatever the actuarial assumed rate of return is (as
set by the Fund Manager), clearly the current financial status of the Plans would
deteriorate further. On the other hand, if the 9% threshold is preserved but no new
assets flow into the Reserves or if the flow is insufficient to cover the annual
adjustment costs, then the Reserves will eventually be drawn down and annual
post retirement adjustments will cease. Additionally, the System's actuary is
going to have to factor in an additional liability amount to account for an annual
Options and Constraints
Page Sixteen
post-retirement adjustment that is subject to a percentage maximum that assures a
net improvement in the Plans' financial condition.
These questions should be referred to the System's actuary for analysis. (See
Attachment J) But if it is determined that a change in the treatment of Plan
Reserve assets improves the current financial status of the Plans (and reduces
what will otherwise be the required FY'O? employer contributions) and the
beneficiaries and participants get the benefit of a pennanent, annual and
constitutionally guaranteed post-retirement adjustment, then the concept may
-- --="~"gha~v~ecm!J,""'e~ri:'o:~tsu':l:':fficientto refer ittQSlaty_ PplicYlJ:!~~rsand the Plan's constituency
groups and their respective organizations. Ihe perceivi<:Cvifu:ed 6Ffiaving=a--"--"-"---­pennanent,
annual and guaranteed post-retirement adjustment might even be
enough to cause the participant groups to be willing to accept a guaranteed annual
increase that is less than 4%. If current statutory provisions remain unchanged and
the Plans receive rates of returns that are consistently less than they were in the
equity bull markets of the late 1990's, then there will be a real risk that the Future
Benefit Increase Reserves of the Plans will be exhausted and annual post-retirement
adjustments will cease.
9. Bonding Option
Given the low interest rate environment that has prevailed over the past few years,
it might have been possible for the State and/or certain other PSPRS covered
employers to issue long-tenn Pension Obligation Bonds (POB's) within the
context of an arbitrage structure. The concept could be summarized as follows.
First, POB's are sold at a relatively low interest rate (i.e. 6% or less); the interest
rate would include the premium that would have to be paid, given that the interest
to the bondholders would be taxable. Second, the proceeds, net of the cost of the
bond sale, are placed in employer asset reserves managed and invested by PSPRS.
Third, the System generates a rate of return on the employer reserve assets that is
well in excess of the employers' debt service on the POB's and in line with the
System's actuarial rate of return assumption. Fourth, the employers' debt service
cost is offset against what the employers would otherwise owe the Plans by way
of employer contributions (calculated as if the POB reserve accounts did not
exist). Fifth, the employer account balances are taken into account in calculating
the employer's future contribution requirement.
There are, of course, a number of financial risks and practical problems associated
with any POB/arbitrage strategy. First, the employer entities must have the
authority to issue POB's; otherwise, some means would have to be found
whereby an entity authorized to issue such securities is also authorized to do so on
behalf of, and for the benefit of, entities that do not have the authority (with an
acceptable assignment of the responsibility for the consequences in the event the
Options and Constraints
Page Seventeen
arbitrage strategy ultimately fails). Second, a POB initiative must not adversely
affect the employer's credit rating. Third, the rate of return generated on the
invested POB proceeds must be greater than the debt service on the bonds. (The
ultimate success of such a strategy cannot be known for certain until the end of
the bond period.) Fourth, the success of a POB sale presupposes the availability of
a market for such securities (and a market at a time when a low interest rate
environment prevails.) Finally, in order to minimize risk, the POB's could only be
marketed, if the interest cost is significantly lower than the System's assumed rate
of return. (Clearly, timing is important.)
Unfortunately, the window of opportunity for a POB 1ll1t1atlve at a reasonab1y===------------­acceptable
risk level has probably passed, given the Federal Reserve's action with
respect to interest rates, and if not, such an initiative may not be feasible in the
credit markets. But even if such an initiative were feasible, it would almost
certainly encounter political resistance because, as a bond arbitrage strategy, it
would entail both short and long-term risk.
C. Increase the PSPRS Plans' Rates of Return
1. Increase Total Return andlor Decrease Risk
The PSPRS Fund Manager may review the asset allocations of the Plans in order
to determine whether the addition of new asset classes (for example, in-house
managed hedge funds) or further exposure to certain asset classes (for example,
private equity or real estate through in-house managed REIT portfolios or direct
real estate investments into new types, such as commercial or multi-unit
residential properties) or broader mandates for existing asset classes (for example,
expanding equity securities selection to include international equities and
emerging market equities) could increase the Plans' total return expectations,
within acceptable risk parameters. In addition, or in the alternative, the Fund
Manager may review the asset allocation of the Plans to determine whether it
would be possible to further diversify away some of the existing risk level to
improve the Plans' prospects for outperforming the assigned benchmarks and the
actuarial assumed rate of return.
If it is deemed possible to achieve either or both objectives, then it would be
necessary to determine whether the strategies designed to achieve these objectives
can be accomplished in-house and, if so, what additional resources would be
necessary for successful implementation. If the System had to make use of
external money managers, specific statutory authorization would have to be
secured.
Options and Constraints
Page Eighteen
D. Conclusion
Although many of the options set forth in the compilation have serious
constitutional, political or practical constraints, there are some that may,
depending on further actuarial and investment analysis and discussion, be' found
to have merit and have the potential to improve significantly the financial
condition of the PSPRS-adrninistered Plans. If so, the PSPRS Fund Manager may
find it appropriate to act upon them (if they are within the control of the Fund
Manager) or recommend them to the Plans' constituency groups and their
------=''=-'='-=-r.epresentathre=:_.organiza1ions and to-the .,' Governor' L_Office .. and .legisl<itiye
policymakers.

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Tami Stowe
Legislative Research Analyst
(602) 542-4962
Arizona House of Representatives
House Majority Research
REPORT
1700 W. Washington
Phoenix, AZ 85007-2848
FAX (602) 542-4511
To:
Date:
Subject:
JOINT LEGISLATIVE AUDIT COMMITTEE
Senator Blendu, Chainnan
Representative Knaperek, Vice Chainnan
December 16, 2005
Sunset Review of the Elected Officials' Retirement Plan, Public Safety Personnel Retirement
System and the Corrections Officers Retirement Plan
Attached is the final report ofthe sunset review ofthe Elected Officials' Retirement Plan, Public Safety
Personnel Retirement System and the Corrections Officers Retirement Plan, which was conducted by the Senate Finance
and the House ofRepresentatives Public Institutions & Retirement Committee ofReference.
This report has been distributed to the following individuals and agencies:
Governor ofthe State ofArizona
The Honorable Janet Napolitano
President ofthe Senate
Senator Ken Bennett
Senate Members
Senator Dean Martin, Cochair
Senator Ken Cheuvront
Senator Jorge Luis Garcia
Senator Jack W. Harper
Senator Jay Tibshraeny
Public Safety Personnel Retirement System
Arizona State Library, Archives & Public Records
Office ofthe Auditor General
Senate Majority Staff
Senate Research Staff
Senate Minority Staff
Senate Resource Center
Speaker ofthe House
Representative Jim Weiers
House Members
Representative Trish Groe, Cochair
Representative Jennifer Burns
Representative Meg Burton Cahill
Representative Steve Gallardo
Representative Marian McClure
House Majority Staff
House Research Staff
House Minority Staff
ChiefClerk
December 16, 2005
COMMITTEE OF REFERENCE REPORT
Senate Finance and House of Representatives Public Institutions & Retirement
Committee of Reference
ELECTED OFFICIALS' RETIREMENT PLAN
PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM
CORRECTIONS OFFICERS RETIREMENT PLAN
Background
Pursuant to §.~ - 953,ArizgJ1a Revised Statutes, the JoiritLe .slative.AuditCommittee
(JLAC) assigned the sunset reviewbfthe Elected Officials' Retiremen Jan(EORP);eublic Safety
Personnel Retirerriel1tSystem (PSPRS) and the Corrections Officers Retirelllent Plan(CQRP) to the
Senate Finance~q fIouse QfJ}~pr~§~J1~tives PublicIl1sti1:l.ltions&:J}etirelll~lltCoriunitteeof
Reference for review: .
The.~ORI?'Ya§established iri1970 to cover state and collilty elected officials, some city
elected officials aIldjudges. The PSPRS was created in 1968 to provide a uniform and consistent
statewide retirement program for public safety per§g~el~9~ghout the state. The CORP \V~
created in 1986 to provide retirelllent benefits for prison and j ail personnel ofcertain. state, SOtplty
and local governments. All threesystems were establishedto~dminister retirementbel1efits as well
as survivor,disability, and health benefits for eligible members and their beneficiaries.
The Fund Manager is a fi memberboardresponsible for the adlllinistration and investment
activities ofthe EQRP, PSPRS and CORP. The Fund Manager develops investment guidelines,
investment policiesartdfunding objectives with the assistance ofindependentinvestlTIentcounsel. A
fund Administratgr is responsible for collecting and refunding contribution§frommembers and
employers, disbursil1g benefits to qualified members in a timely manner aIld irl"esting.monies as the
Fund Manager determines necessary and prudent to meet investmentobjectives and accruing benefit
obligations.
Committee ofReference SunS'etReview Procedures
The Committee ofReference hel .bne public heating.....,~'''''.·.w'''.,, ..i~'''.~''''''',.'''r,~''''w''If''''.~'''moM'-''''"-mo." ""'''''~''''''~N'''_...,....J''''''"'''''''''''',,,._'.,''''>'M''''''.~'','-''',""''''''''''',''''''',,·.,,~~ __~'''''·.~"'B'~''''''''.'..''_,,·~;,'''·~~lil'·''''''' ...._··Mn''''''''"
Total fund 7
00
nvestment Portfolio Returns
June 30,2005
Total Fund
Benchmark*
ASRS
COPERS
1 Year
9.2%
6.3%
8.5%
8.6%
3 Year
10.2%
7.0%
9.2%
9.2%
5 Year
-1.1%
3.0%
2.2%
3.7%
10 Year
8.17%
8.0%
9.4%
n/a
eBenchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% J-fBill
!,)t und 9
Total Fund vs Benchmark
June 30,2005
25.000/0-" i
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
-20.000/0fiiii9~k6k T* igig;W *Twiggs' 'T@l ii999'UT& &20&00% r 2ooi'r 2oo~kM'l '6Sii;003 1M§! r;,,~oo~§ 'ilrhi;005whr
(I Total Fund I 16.40% 123.42% 1 22.11% I 17.67% 1 12.47% 1-16.89%1-15.04% 1 6.61% 1 14.94% I 9.15%
EJ BenchlTark* I 13.98% I 17.87% I 17.66% I 11.94% I 5.75% I -1.07% I -4.13% I 6.18% I 8.38% I 6.32%
,..,.r_1"'''''''''''''A"I.;1~''','".''''"''''' ..'''-;,-,.,,>''''''~...,.·'"
-Benchmark 45% sap 500, 45% Lehman Gov/Credit, 10% T-Bill
10
Total Fund Actuarial Assets and Liabilities
June 30,2005 (thousands)
June 30, 2005
. $6,104,548
ITotal Liabilities $6,292,02911 Total Liabilities $7,218,720 I
I II I I Funding Ratio . 94.5% I I Funding Ratio 84.5% I
L.__.__...__........._..._..._.J I................__._.__._....__.___....J
""'lI;Wm""..,,'''''''''''~'_·''"· __...'»·...._'>l..,_'''''f''.'''"'''"'..wn........''''r~.m'''.''i'~.~~·~'''' ...'''''~~·~",.,,'''_.''''_".j.''' ....,''''''''"'''''''''''.......;..._,,".'''''.''i''='''''''''''''''"'''''..#.~,""""\ ...."'n,_.~..m"·,...__r:p"''' ""''''\_''_'>''n'~''IJa'''',''_~.
Total fund 11
Book Value vs Market Value
June 30, 2005 (millions)
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0,
1996 I 1997 I 1998 1999 2000 2001 2002 2003 2004 2005
Ill} Market I 3,355 I 4,137 I 5,034 5,897 6,589 5,431 4,548 4,725 5,325 5,708
o Book I 2,838 I 3,161 I 3,530 4,291 4,718 4,939 4,973 4,416 4,501 4,736
Total fund 12
-----
.... - ~ ~
¥"''''''''''''!''"''''ft'__rr~'_''.''-'''1WI1O''''J\.,_....,_..m"",__..._..~l!o/,.~ ..."~""',.-.....,."-"'~,,,'\1"-«I;''''..m,,~.,.''''''''''''''''''''''''''''''"''''''.!!''''.'.'.=.,''''''''y''''"''''''''''',','''''''."~..-tW'T,f:.1'?I«""'\...,"""'.~'''''''W'lm~'''''\\','~~,''''' ..'.''-r''W.,.iJ'''''''-...'..'':'',~.WN'M''''j~-~""n:;-,_.·"""··~'"""''''_~,.~,,\'''W' ..,,n,">l.,..J-'';''',;;.'''"''n''''''''',.l''#;i!'_'-',, "·!IM"·"'''''''i!'~·t.M"."',;I'''"''''''''''''M_"",,,,,,~'''''''~~'",'':ll''''''''_'$'''''''"W·_"!I?')~"'''''~'¢')._·'''''~'_''~.''''''M''''·X·'':' __-'·'
Added & Lj"
00
00
o
~ Va.lue
Added & tiigh
o Cost
o o
Low Vafue Added
& High Cost
CostiEffectiveness :Ranking
2004 AU Funds Value Added vs Excess Cost: Ari:zona Public Safety
Retirement System Value Added 1.7% vs Excess Cost. -23.8bp
o
Added & High
Cost
o
°
o
°ro 6b
o
o
o
o 0o°
Added & Low
Cost
o
"0
'OJ
"'0
"0 «
4)
:::l
ro
>
o
Low Value Added
& Low Cost
Low Value Added
& High Cost
"t . I
Excess Costs
Administrative Expense
(% of Assets)
/ "',
/' ~
~
./
- ....-- ----- .-/'
I I
0.120%
0.100%
0.080%
0.060%
0.040%
0.020%
0.000%
t;Jjfo
~
~
~
~
~
~
~
~ ~ty ~ ~
~ ~ ~ ~
~ ~
~ ~
-Total fund -CEM US Universe
- NASRA Public Fund Survey- Median -NASRA -Public Fund Survey- Average
"IIr1\~""",,_,"'''''''''"''''''''''._,",,",=''''''''''~-''''''''''''''''''''''~'''l>o.,.'''''''''''''''''''_'/M11fI~'''''~''!'Ill!'''''''''_''~l'I'M'"'_f;' _"li"""""~"'__~_!''''',(_''''''''''~'''..l''I''''''''·'>W>~-=''''''iMl.'_'''';'''_~,''!''ll'O'''''''t_·.;''''"~MIl'."~"..~.r~"".;""'r_1'1>"1t'''''''*,'.J''I'M'''.'''''''''"''''''''''''',-.''.';'''·>.ct.'~·~~~:,".r'-'''~''''''M:-.'~''-''''''.n",'_",,''_''',..,'M
I­w
II:
LL o
en
w
l­e:(
II:
en
II: c. en c.
PSPRS RATES OF RETURN
Estimated
S&P 500 S&P 500 S&P 1500 S&P 500 S&P 500 S&P 1500
Balanced Actual Actual Balanced Actual Actual
Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD Month FYTD
PSPRS CORP
07/31/05 3.3% 3.3% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6% 3.3% 3.3% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6%
08/31/05 2.0% 5.3% 0.3% 1.5% -0.3% 2.1% -0.4% 2.2% 1.9% 5.3% 0.3% 1.5% -0.3% 2.1% -0.3% 2.2%
09/30/05 0.5% 5.8% -0.2% 1.3% 0.3% 2.4% 0.3% 2.6% 0.4% 5.7% -0.2% 1.3% 0.3% 2.4% 0.3% 2.5%
10/31/05 -1.5% 4.2% -1.1% 0.2% -1.3% 1.1% -1.4% 1.1% -1.5% 4.1% -1.1% 0.2% -1.3% 1.1% -1.4% 1.2%
11/30/05
12131105
01/31106
02128/06
03/31/06
04/30/06
05/31/06
06/30/06
EORP TOTAL FUND
07/31/05 3.1% 3.1% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6% 3.3% 3.3% 1.2% 1.2% 2.4% 2.4% 2.6% 2.6%
08/31/05 2.0% 5.2% 0.3% 1.5% -0.3% 2.1% -0.4% 2.2% 2.0% 5.3% 0.3% 1.5% -0.3% 2.1% -0.4% 2.2%
09/30/05 0.4% 5.6% -0.2% 1.3% 0.3% 2.4% 0.3% 2.6% 0.4% 5.8% -0.2% 1.3% 0.3% 2.4% 0.3% 2.6%
10/31/05 -1.6% 4.0% -1.1% 0.2% -1.3% 1.1% -1.4% 1.1% -1.5% 4.1% -1.1% 0.2% -1.3% 1.1% -1.4% 1.2%
11/30/05
12131105
01/31/06
02/28/06
03/31/06
04/30/06
05/31/06
06/30/06
S&P 500 BALANCED INDEX - 45% S&P 500 + 45% Lehman + 10% 91-Day T-Bill
S&P 500 ACTUAL WEIGHTED - Actual asset allocation percentages applied to S&P 500, Lehman, 91 Day T-Bill Indices and Expected Annual Return for Real Estate
of 8%.
S&P 1500 ACTUAL WEIGHTED - Actual asset allocation percentages applied to S&P 1500, Lehman, 91 Day T-Bill Indices and Expected Annual Return for Real
Estate of 8%.
!~Iit~
i:
~Ii~I
.~
~:
~
~!
,
leD 10)
IC
leD )iI~
I.e
10 !I
"'0 Ic
letS II IE ~"eD I­i
.c
10 !~ 10- IleD i.e
II- i,
CORP ~ Funding Levels
160.0% .--------------------.
140.0% +1--
120.0% +1--1
100.0% +1--1
80.0% +1-----,
60.0% +1--
40.0% +--
20.0% +--
0.0% -'---
06/30100 06/30101 06/30102 06/30103 06/30104 06/30105
IFunding 140.6% 140.0% 123,8% 106.9% 104.8% 96.4%
3
EORP - Funding Levels
160.0%
140.0% ~ I I I
120.0% I I
100.0% I I
80.0% I I
60.0% I I
40.0% I Fe·
20.0% I I
0.0%
06/30100 06/30101 06/30102 06/30103 06/30104 06/30105
IFunding 130.1% 141.7% 125.5% 118.7% 104.4% 95.5%
m."'~""-,'I'''~''''lN'''');,""'':\';J'''':lJ'''''''''''M'!'J''')"'''''''''''''J'-'''",,,,,,0\\,,,
4
PSPRS - Aggregate Employer Rates
18.00°1!),"'"',__1'l""',-"','>,...""""lW!""'"_,......'l'i"""'M"'H",-",,,,,,,..~.,,,,,,,··,;,,,,,,, ....,,,,,,,",,,,"'·'~W""iq,,,,,,,,,,,,,-·,,,'''''''.'''''''''''''~'_~''''"'''''''''~'''''''''_''_,~''''_~·''''',""·l'-'''_'''''''',·,=~''1'f,,, -"'""""·"""' .•,',....U".""".,,.,~.il"'.,~__.·~~""__-''''''''''''''.=.·,'''},,...~.fO...._~""."""...""""'''''''_'''"..''''''__. -_~.,...'"...,="....,...~,,.,M%' .."'."""'I'>'"""""_'''''''''''''"".',-''''''''_......~..·..'''·'"~'''''MJ>_'~_"'i"'''~1''"'J,. .•.•
10
Constraints
Prohibition against diminishment of pensions
o Arizona constitution
o Arizona case law (Yeazell v. Copins)
Political Constraints
11
i!I
o
o
o
Options Available
Reducing the System's salary growth assumption;
~~~ Considering a change in actuarial methodology;
Lengthening the PSPRS unfunded liability amortization period;
~~ Marking to market the PSPRS Plans' real estate and other alternative
investments;
Reviewing the PSPRS Plans' asset allocations;
New asset classes
Greater exposure to certain existing asset classes
Broader mandates for existing asset classes
Re-examining the treatment of the assets in the PSPRS Plans' Future
Benefits Increase Reserves;
til Increasing employee contribution rates;
If Reducing the rate of interest credited to PSPRS DROP accounts; and
Assessing contributions with respect to compensation paid to future
PSPRS DROP participants.
12
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N
Plan Statistics
Defined Benefit Plan - June 30, 2005
Active Members
Terminated Vested Members
DROP
16,317
104
1,472
Retired
Members
Beneficiaries
Disability
Total Participants
4,733
943
1,012
PSPRS
6,688
24,581
2
Pian Statistics
Defined Benefit Plan
As of June 30, 2005
Actuarial Value Market Value*
Assets
Funding Ratio
As of June 30, 2004
Assets
Funding Ratio
$4.9 Billion
82.1%
Actuarial Value
$4.8 Billion
92.4%
$4.1 Billion
68.4%
Market Value*
$3.7 Billion
72.4 %
*Market Value does not include Future Benefit Increase Reserve
PSPRS 3
Total Revenue
June 30, 2005
Investment Income
$383,530,412
68%
Employer
Contributions
$104,497,150
18%
PSPRS
Member Contributions
$67,947,506
12%
Service Purchase
$9,156,465
2%
4
Total Expenses
June 3D, 2005
5
Transfers
$259,692
0.1%
PSPRS
Administrative Exp
$1,599,784
0.6%
Refunds
$7,647,443
2.9%
Insurance
$11,417,919
4.3%
Drop Benefits
$15,265,160
5.7%
Survivor Benefits
$25,357,132
9.5%
Disability Benefits
$28,883,283
10.8%
Net Cash Flow
FYE June 30 (thousands)
($10,000)
($20,000)
($30,000)
($40,000)
($50,000)
($60,000)
($70,000)
($80,000)
($90,000)
($100,000) I 1996 -
• Net Cash Flow I -7,198
1997 I 1998 I 1999 I 2000
-12,670 I -26,585 I -33,085 I -51,231
2001 I 2002 I 2003 I 2004 I 2005
-60,493 I -71,174 I -97,205 I -85,416 I -85,224
EE & ER Contributions less Benefit Payments and Expenses
PSPRS 6
Asset Allocation at Market
June 30,2005
Cash
$279,083,870
6%
Real Estate
$194,104,748
4%
PSPRS 7
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Investment Portfolio Returns
June 30,2005
1 Year
Public Safety 9.1%
Benchmark* 6.3%
ASRS 8.5%
COPERS 8.6%
3 Year
10.2%
7.0%
9.2%
9.2%
5 Year
-1.1%
3.0%
2.2%
3.7%
10 Year
8.2%
8.0%
9.4%
nja
*Benchmark 45% S&P 500,45% Lehman Gov/Credit, 10% T-Bill
PSPRS 9
Public Safety vs Benchmark
FYE June 30
25~ i
20
15
10
5
o
_5.J..1t---------------------1
-10.J..It---------------------J
-15
2000 2001 2002 2003 2004 2005
12.31 -16.86 -15.07 6.67 14.97 9.11
5.75 -1.07 -4.13 6.18 8.38 6.32
PSPRS 10
-20-1 t 19961· 1997T 1998 i 1999
511' ",."' I ;. Ti d"r i r
*Benchmark 45% S&P SOD, 45% Lehman Gov/Credit, 10% T-Bill
IliJJ PSPRS I 16.45 I 23.43 I 22.24 I 17.69
• Benchmark* I 13.98 I 17.87 I 17.66 I 11.94
Total Actuarial Assets and Liabilities
June 30, 2005
(thousands)
Total Assets $4/886/963
Total Liabilities $5/951/937
June 30, 2004
(thousands)
Total Assets $4/774/313
Total Liabilities $5/167/333
Funding Ratio 82.1% Funding Ratio 92.4%
PSPRS 11
Book Value vs Market Value
FYE June 30 (millions)
6,000
5,000
4,000
3,000
2,000
1,000
Investment Expense
FYE June 30 (0/0 of Assets)
- - ~----------
0.400% I I
0.350%
0.300%
0.250%
0.200%
0.150%
0.100%
0.050%
0.0000/0 I i I I i I I I I I I
p,b
~
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- Public Safety -CEM Benchmark Calculation
--*CEM US Universe ,- NASRA Public Fund Survey- Median
-NASRA -Public Fund Survey- Average
*"Comparison of costs to the universe must be interpreted with extreme caution given the breadth of the
universe which encompasses funds with widely varying size and asset mix. Your benchmark cost calculation,
is a much more valuable indicator as to whether you are a low or high cost producer since it adjusts for
differences in fund size and asset mix." Cost Effectiveness Measurement Inc, 2005 pg 12
PSPRS 13
Administrative Expense
FYE June 30 (DID of Assets)
0.120%
0.100%
0.080%
0.060%
0.040%
0.020%
"/' -"'"- ~ ~
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- NASRA Public Fund Survey· Median - NASRA ·Public Fund Survey· Average
PSPRS 14
Changing Financial Status
@IUU ~~if;\\WJ:ili~:~NS",",l'H'!ifc1tJt\;J!
Actuarial Actuarial
FYE 06/30 Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $ 2,487,953 $ 2,328,276 106.9% $ 2,655,351 114.0%
1997 $ 2,915,173 $ 2,533,435 115.1% $ 3,097,720 122.3%
1998 $ 3,192,627 $ 2,743,998 116.3% $ 3,628,536 132.2%
1999 $ 3,709,251 $ 3,082,202 120.3% $ 4,095,630 132.9%
2000 $ 4,260,168 $ 3,415,157 124.7% $ 4,516,110 132.2%
2001 $ 4,661,941 $ 3,674,758 126.90/0 $ 3,759,164 102.30/0
2002 $ 4,684,386 $ 4,144,211 113.0% $ 3,193,862 77.1 %
2003 $ 4,781,377 $ 4,739,613 100.9% $ 3,364,413 71.0%
2004 $ 4,774,313 $ 5,167,333 92.4% $ 3,741,116 72.4%
2005 $ 4,886,963 $ 5,951,937 82.10/0 $ 4,070,529 68.4%
*Market value does not include future benefit increase reserve
PSPRS 15
V)
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CORP Plan Statistics
Defined Benefit Plan
Active Members
Terminated Vested Members
11,752
130
Retired
Normal
Beneficiaries
Disability
Total Participants
1,339
314
80
CORP
1,733
13,615
2
CORP Plan Statistics
Defined Benefit Plan
As of June 30, 2005
Assets
Funding Ratio
As of June 30, 2004
Assets
Funding Ratio
Actuarial Value
$873 Million
96.4%
Actuarial Value
$834 Million
104.8%
Market Value*
$747 Million
82.5%
Market Value*
$673 Million
84.6%
*Market value does not include Future Benefit Increase Reserve
CORP 3
Employee
contributions
34,589,714
29%
Employer
Contributions
16,291,914
14%
Total Revenue
June 30, 2005
Service Purchase
2,267,921
2%
CORP
Investment Income
66,277,084
55%
4
Total Expenses
June 30, 2005
Refunds
$16,652,638
33%
Insurance
$2,400,849
5%
Transfers
$1,115,311
2%
Suvivor Benefits
$3,871,675
8%
CORP
Admin Exp
$922,183
2%
Disability Benefits
$1,305,434
3%
Normal Retirements
$23,519,992
47%
5
Net Cash Flow
FYE June 30 (thousands)
$25,000 I i
1996 1997 I 1998 I 1999 I 2000 I 2001 I 2002 I 2003 I 2004 2005
$0
$5,000
$10,000
$15,000
$20,000 +1------i
• Net Cash Flows 18,175 20,863 I 22,621 I 23,200 I 18,762 I 13,986 I 3,654 I 912 I 4,996 3,361
EE & ER Contributions less Benefit Payments and Expenses
CORP 6
Asset Allocation
June 30,2005 (at Market)
Bonds
161,755,247
21%
Real Estate
32,953,273
4%
Cash
44,236,811
6%
CORP 7
00
Investment Portfolio Returns
FYE June 30
CORP
Benchmark*
ASRS
COPERS
1 Year
9.2%
6.30/0
8.5%
8.6%
3 Year
10.0%
7.0%
9.2%
9.2%
5 Year
-1.2%
3.0%
2.2%
3.7%
10 Year
8.0%
8.0%
9.4%
n/a
*Benchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% T-Bill
CORP 9
CORP Plan vs Benchmark
FYE June 30
25.00%
-5.00%
O.OOO/o~
5.00%
20.00%
10.00%
15.00%
-15.00%
-10.00%
1996 1997
o CORP 115.30% I 22.74% 121.68% 117.60% 113.22% 1-17.07%1-14.73%1 6.15% 14.77% I 9.23%
• Benchmark* 113.98% 117.87% 117.66% 111.94% 1 5.75% I -1.07% I -4.13% I 6.18% 8.38% I 6.32%
*Benchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% T-Bill
CORP 10
Total Actuarial Assets and Liabilities
96.4%
(in thousands)
$872,981
$906,025
104.8%
Total Assets
r··..·....·....·......·..··..·..·....·..·....J'~·~~ .·3·0~·····2004 .·.·.·.·.·.·.·\
i (in thousands) II
$833,621 I,iI
$795,775 II
I
I Total Liabilities
!
1!I
Funding Ratio
!iI!!
,\
..
[--------J~~~-30;-2005---------j
!!!f ITotal Assets
I:
ITotal Liabilities
iI
!Funding Ratio
iIIi
j
\0 J
CORP 11
Book Value vs Market Value
FYE June 30 (in thousands)
$900,000
$800,000
$700,000
$600,000
$500,000
$400,000
$300,000
$200,000
$100,000
$0 I 1996 1997
o Book $309,150 $365,414
• Market $347,932 $449,637
1998
$426,352
$571,261
1999
$519,862
$696,231
$588,205
$807,766
CORP
$631,618
$683,192
2002
$646,862
$586,328
2003
$587,318
$622,939
2004
$615,696
$719,235
2005
$662,258
$788,874
12
----
- .--.-----------
Investment Expense
FYE June 30 (% of Assets)
0.4000/0 I i
0.350%
0.300%
0.250%
0.200%
0.150%
0.100%
0.050%
0.0000/0 I ( Iii ( Iii i I
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-Corp -CEM Benchmark Calculation
-CEM US Universe - NASRA Public Fund Survey- Median
- NASRA -Public Fund Survey- Average
"Comparison of costs to the universe must be interpreted with extreme caution given the breadth of the
universe which encompasses funds with Widely varying size and asset mix. Your benchmark cost calculation,
pg 10, is a much more valuable indicator as to whether you are a low or high cost producer since it adjusts
for differences in fund size and asset mix." Cost Effectiveness Measurement Inc, 2005 pg 12
CORP 13
0.140%
0.120%
0.100%
0.080%
0.060%
0.040%
0.020%
0.000%
Administrative Expense
FYE June 30 (% of Assets)
...--/_. /~ -- .----- /' -~'-./ --- --' -
---------
~ ~ ~ : I # # i ~ ~
~ ~ ~ ~ ~ ~ ~ ~ ~ ~
-CORP
-- CEM US Universe
- NASRA Public Fund Survey- Median
- NASRA -Public Fund Survey- Average
CORP 14
Changing Financial Status
Actuarial Actuarial
FYE 06/30 Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $ 319,255 $ 290,518 109.9% $ 347,028 119.5%
1997 $ 393,904 $ 355,950 110.8% $ 448,281 126.1%
1998 $ 484,956 $ 410,531 118.1% $ 555,751 135.4%
1999 $ 592,152 $ 443,676 133.5% $ 653,777 147.4%
2000 $ 704,991 $ 501,323 140.6% $ 747,981 149.2%
2001 $ 776,177 $ 554,387 140.0% $ 637,372 115.0%
2002 $ 782,446 $ 632,238 123.8% $ 551,876 87.3%
2003 $ 811,791 $ 709,298 114.4% $ 592,230 83.5%
2004 $ 833,621 $ 795,775 104.8% $ 673,322 84.6%
2005 $ 872,981 $ 906,025 96.4% $ 747,458 82.5%
*Market value does not include future benefit increase reserve
CORP 15
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E()RP Statistics
Defined Benefit Plan -Jun.e301 2005
Active Members 781
Terminated Vested Members 87
Retired
Members
Beneficiaries
Disability
Total Participant
600
18
151
EORP
769
1,637
2
EORP Statistics
Defined Benefit Plan
As of June 30, 2005
Assets
Funding Ratio
Asof.lune30,2004
Assets
Funding Ratio
Actuarial Value
$344,604
95.5%
Actuarial Value
$343,376
104.4%
Market Value*
$287,882
79.8%
Market Value*
$268,214
81.5 %
*Marketvalue does notinclude Future Benefiflncrease Reserve
EORP 3
-rota I Revenue
June 30, 2005
Employee
contributions
$3,617,383
9%
Court Fees
3,792,729
9%
Employer
Contributions
3,304,513
8%
Service Purchase
3,646,744
9%
EORP 4
Total Expenses
June 30, 2005
Admin Expense
$131,655
0.5%
Transfers
$246,091
0.9%
Suvivor Benefits
$3,671,914
14.0%
EORP
Disability Benefits
$1,073,453
4.1%
5
I\JetCash F.low
FYEJune30 (in thousands)
$0
($2,000)
($4,000)
($6,000)
($8,000)
($10,000)
($12,000)
($14,000) .
1996 1997 I 1998 I 1999 I 2000 12001 L 2002 I 2003· '.2004 I 2005
��� Net Cash Flows I -2,413 I -2,496 I -3,363 I -5,262 I -4,215 \-9,0251-11,907 1-12,333\ ..12,957 I -11,845
EE &ER Contributions less Benefits Payments and Expenses
EORP 6
Asset Allocation
June 30,2005 at Market
Real Estate
13,192,646
4%
Bonds
64,673,263
21%
EORP
Cash
15,995,477
5%
7
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Investment Portfolio Returns
as of FYE June 30, 2005
EORP
Benchmark*
ASRS
COPERS
1 Year
9.6°10
6.3°/0
8.5°/0
8.6°/0
3 Year
10.4°/0
7.0°/0
9.2°/0
9.2°/0
5 Year
-1.1°/0
3.0°/0
2.2°/0
3.7°/0
10 Year
8.4°/0
8.0°/0
9.4°/0
n/a
*Benchmark 45% S&P500, 45%Lehman Gov/Credit, lOO/oT-Bill
EORP 9
Elected Official vs Benchmark
FYE June 30
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
-20.00% .
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
[] EORP 117.70% 124.59% 121.26% 117.51% 113.20% 1-16.96%1-15.36%1 6.69%
• Benchmark* 113.98% 117.87% 117.66% 111.94% I 5.75% 1-1.07% 1 -4.13% I 6.18%
*Benchmark 45% S&P 500, 45% Lehman Gov/Credit, 10% T-Bill
EORP
15.02% 19.56%
8.38%1 6.32%
10
'-()taliActuiarialAssetsancl.. L.ia bi lities
June 30, 2005
(in thousands)
June 30, 2004
(in thousands)
Funding Ratio
ITotal Assets $344,604 I ITotal Assets $343,376
ITotal Liabilities $360,75811 Total Liabilities $328,921
I I
95.5% IFunding Ratio 104.4% I
, I I : \ .:
EORP 11
Baal< iVaiue vs !VIarlJune 30 (°10 of Assets)
0.:1.20% I I
0.:1.00% I ;/ , I
0.080% I ~ ==" I
0.060% •I I
0.020% .-1 ~ I
0.040% . I ~ I
0.000% I I I I I I I i I I I
~ ~ ~: ~ ~ ~ ~ ~ ~
~.. ~ ~. ~ ~. ~... ~. ~.. ~.. ~
--Elected Officials -CEM US Universe
- NASRA Public Fund Survey- Median -NASRA-Public Fund Survey-Average
EORP 14
ChangingFinanciaI Status (in thousands)
Actuarial Actuarial
FYE 06/30 Asset Value Liabilities Funded Ratio Market Value* Funded Ratio
1996 $ 181,754 $ 158,126 114.90/0 $ 210,397 133.1%
1997 $ 214,035 $ 169,593 126.2% $ 256,524 151.3%
1998 $ 241,884 $ 199,662 121.10/0 $ 281,567 141.00/0
1999 $ 283,337 $ 227,100 124.80/0 $ 319,010 140.5%
2000 $ 329,777 $ 253,478 130.1% $ 355,335 140.2%
2001 $ 355,768 $ 250,987 141.7% $ 291,723 116.20/0
2002 $ 351,349 $ 279,947 125.5% $ 242,167 86.50/0
2003 $ 353,463 $ 297,892 118.7% $ 251,019 84.3%
2004 $ 343,376 $ 328,921 104.4% $ 268,214 81.5%
2005 $ 344,604 $ 360,758 95.5% $ 287,882 79.8%
*Market value does not include future benefit increase reserve
EORP 15
PSPRS FUNDING STATUS IMPROVE:MENT OPTIONS
AND
CONSTRAINTS
Challenge
Despite the fact that the three Retirement Plans that PSPRS administers have earned
above market returns over the past two fiscal years, their financial status has deteriorated
significantly since June 30, 2001 (FY'Ol). Unlike the situation at June 30, 2003 (FY'03)
in the case of the Public Safety Personnel Retirement System (PSPRS) Plan, and at June
30,2004 (FY'04) in the case of the Corrections Officer Retirement Plan (CORP) and the
Elected Officials Retirement Plan (EORP), all three Plans now have funding ratios of less
than 100% as ofthe end ofFY'05.
In the case of PSPRS, its funding ratio at the end of FY'Ol was 126.9%. By the end of
FY'04, the ratio had declined to 92.4%. By the end of FY'05, the funding ratio had
slipped to 82.1%.
In the case of CORP and EORP, their FY'Ol funding ratios were 140% and
141.7%respectively; but by the end of FY'05, their ratios had declined to 96.4%, in the
case of CORP, and 95.5%, in the case of EORP -- ratios indicative of still well-funded
plans but ones with new asset deficiencies.
Of course, as the three Plans have moved from positions of asset surplus to positions of
asset deficiency, the required employer contributions have increased markedly. While the
Plans held excess assets, those excess assets, expressed as a level percent of payroll and
amortized over twenty year rolling periods, had the effect of keeping employer
contribution rates abnormally low, relative to employer "normal cost" (i.e., the employer
share of the cost, expressed as a level percent of payroll, of the addition to liability that
resulted from the covered group's service credit accruing in any given year). Now with
unfunded liabilities existing in all three Plans, the cost of amortizing those unfunded
liabilities, expressed as a level percent of payroll and amortized over twenty year rolling
periods, must be added to what would otherwise be the employer normal cost, thus
inflating the employer contribution rates to higher levels.
Options and Constraints
Page Two
In the case of PSPRS and based on that System's financial status at June 30, 2001, the
FY'03 aggregate employer contribution rate was only 4.46%. However, given the PSPRS
financial results as of the end of FY'05, the aggregate employer contribution rate
projected for FY'07 is up to 17.1%. By comparison, the PSPRS employee contribution
rate, which is set by statute, is only 7.65%
For the CORP, the FY'03 aggregate employer contribution rate was only 2.14%, based
on the Plan's FY'01 financial results. Now, based on the Plan's FY'05 financial results,
the aggregate employer contribution rate projected for FY'07 is 7.06% -- a rate that is
lesstba.nthe statlltory8.5%employeerate,but stillone that is 410% of what it was in
~~~~~FY=-'03. . . . .
Finally, for the EaRP and based on its FY'01 financial results, the FY'03 employer
contribution rate was 7.55%. Now, based on the Plan's FY'05 financial results, the
projected FY'07 employer rate will be 24.27%.
Unfortunately, and even despite the good investment performance of the past two years,
the near-term expectation is for further erosion in the funding ratios of all three Plans.
The challenge that is posed, given the present and projected situation is simple: Without
impairing the fiscal integrity of the Plans,what can be done to ameliorate or reduce what
will otherwise be relatively large required employer contribution rate increases in FY'07
- increases that are certain to present budgetary problems for the three Plans'
participating employers at the State, county and municipal levels?
Contributing Factors
The principal factors that have, in the aggregate, contributed to the erosion in the funding
ratios of the Plans and to the significant rise in the employer contribution rates are as .
follows. First, there is the very significant loss in asset values attributable to the 2001
through 2002 financial market contractions, the effects of which are not yet fully
reflected in the Plans' actuarial value of assets. Those asset values are determined
annually based on a rolling seven year average.
The second factor relates to PSPRS' having to reflect actuarially the investment
environment in which the Plans are operating. Clearly, the current investment
environment is not as positive or robust as that which prevailed throughout the last half of
the 1990's. In recognition of that reality, the System has begun to reduce its former 9%
actuarially assumed rate of return in one quarter of one percent increments. For FY'05,
the assumed rate was 8.75%. During the current FY'06, the rate is 8.5%. The System's
actuary has said that everyone quarter of one percent reduction in the actuarial rate of
return assumption results in a one and one-half percent increase in the employer
contribution rate requirement. Although the System's Fund Manager will likely pause to
Options and Constraints
Page Three
assess whether the System's latest rate of return assumption reasonably reflects the true
rate of return experience of the Plans, it is possible that even further reductions in the
assumed rate may be necessary in the future.
A third factor that has the effect of suppressing the Plans' actuarial value of assets and
their funding ratios is the way in which the Plans are statutorily required to pre-fund
annual post-retirement benefit adjustments. Under current law, either one-half (in the
case of PSPRS and CORP) or all (in the case of EORP) of the Plans excess investment
returns (i.e., investment returns in excess of 9%) must be allocated to each Plan's Future
Benefits Inc:rease R.eserve. A.s sllch,theassets in t~ese reserves ($537.5 million for
-----.·"'p.-nSpRS,n $zn-:zl: ~nill.lionfb.r -roRP~aIrd--$-23~liori4:{)r-EeR-p--=a~~0f--FY-'-O§j=and=th€-----
earnings thereon are not included in the calculation of the Plans' actuarial value of assets,
and that, in turn, negatively impacts the Plans' funding ratios and their employer
contribution rates. Furthermore, some have argued that excess earnings should never be
siphoned off or allocated to fund future, additional benefits, for, to remain actuarially
sound, the Plans need to retain excess earnings merely to offset the poor investment
returns the Plans are certain to experience from time-to-time.
The fourth factor relates to the value the System assigns to the Plans' Alternative
Investments Asset Class. By custom and practice these investments (i.e., primarily real
estate investments along with a relatively small exposure to private equity) are carried at
cost. However, since these investments currently have net market value significantly in
excess of cost, the Plans' actuarial value of assets is understated. This, too, causes the
Plans' funding ratios to be understated and the required employer contributions to be
overstated.
The fifth factor comprises the benefit improvements made in recent years that have added
significantly to Plan liabilities. The major addition was the creation of the Deferred
Retirement Option Plan (DROP) for the PSPRS Plan. Although it was created as a "pilot"
program for the period from 2001 to 2006, the DROP was made permanent in 2002. The
original twenty-five year service requirement for DROP participation eligibility was
reduced to twenty years in 2001. Other legislated changes that took effect in 2002 were
the increase in the PSPRS survivor benefit from 75% to 80%, the permanent 2% tax
equity increase in pensions for employees hired before 1989, and an increase in the duty
death spousal benefit from 50% to 100% of average compensation. Additionally, in 2001,
the post-retirement health insurance subsidy amounts were significantly increased.
Finally, an enhanced refund provision was enacted several years earlier.
The final factor relates to certain economic and demographic actuarial assumptions that
have had the net effect of enhancing the Plans' projected rates of liability growth.
Options and Constraints
Page Four
Constraints
There are a number of constraints that will limit the options available to the PSPRS Fund
Manager and to policymakers for enhancing the financial condition of the Plans and
reducing what will otherwise be the required employer contribution requirements for
FY'07. These include:
A. The Arizona Constitution's prohibition against diminishment of
contractual pension rights and the Arizona case law (beginning with
the Yeaz~ny. CopillS case) related to this issue. (See Attachment A);
B. The Existing unfunded liabilities of the retirement Plans; and
C. Political Factors.
A line of Arizona state court decisions, beginning with the 1965 case of Yeazell v.
Copins, stand for the proposition that pension benefits are a matter of contractual right
that cannot be diminished or impaired once vested. ill addition, Article ~IX, Section 1,
Paragraph C of the 1998 version of the State's Constitution clearly stat~s that "....
public retirement system benefits shall not be diminished or impaired." .
Given the Arizona case law and the State Constitution's prohibition against pension
benefit diminishment, it should be clear that, in general, the existing structures of benefits
probably cannot be reduced for current system beneficiaries or participants.
Options to Reduce the Rate of Plan Liability Growth, Increase Plan
ContributionslIncome and/or Assets and Increase the rate of Asset Growth
Although there are a variety of options available to the PSPRS Fund Manager and to
policymakers to enhance the financial condition of the System's Plans and thereby reduce
what will otherwise be the employer contributions required in FY'07, based on FY'05
results for the Plans, many of them have constitutional and/or political or other problems
that impair their viability either partially or completely. Here is a review of the most
obvious ones. These options would either reduce the rate of liability growth, or increase
Plan contributions/income and/or assets or increase the rate of Plan asset growth.
A. Reducing the Rate of Future Liability Growth
1. Creating a Second Tier Defined Benefit Plan (DB) for New Hires
Without violating the pension protection clause of the Arizona State Constitution
(i.e., Art. XXIX, Sec. 1, Paragraph C), new, simplified, and significantly less
Options and Constraints
Page Five
generous defined benefit (or cash balance) plans could be designed to cover
newly-hired participants in the three Plans that PSPRS administers. This option
would slow the rate of growth in liabilities in the distant future; it would,
however, do little to improve the financial status of the Plans in the near-term and
ease the employer contribution burden. (There is some uncertainty as to whether
future benefits for current Plan participants who have not yet "vested" could be
reduced without violating the Constitution due to the Court of Appeals' decision
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The process for developing/designing a new pension plan for new hires could be
undertaken as follows: First, the criteria or objectives for the new plans would be
specified. For example, the criteria/objectives might call for plans that are,
relative to the existing Plans, less expensive and have, relative to the current
Plans, later normal retirement ages, later early retirement ages, longer vesting
requirements, benefit formulas with lower accrual rates, periods longer than three
years for averaging final salary, less generous survivor benefit formulas, less
generous disability benefit formulas and more stringent eligibility requirements
and a post-retirement cost-of-living adjustment that is tied to the movements of
the Consumer Price Index (C.P.i) and capped at some limit (for example 3%).
Another factor to be considered is whether social security coverage is or is not
available. Social security coverage, or the absence thereof, would have
consequences for both plan design and cost.
Second, once the criteria/objectives are specified, a pension plan consulting
andlor actuarial firm could be asked to develop the specifics to implement and
achieve the specified criteria/objectives, taking into account differences among
the new hire employee groups who would be served by the new plans.
Third, once the designs for the plans are complete and in order to know the extent
of the future savings in pension costs, actuaries would be asked to project the cost
for the new plans and compare them to the projected costs for the current plans if
they were to continue to apply to the new hire groups.
Finally, the legislation to implement the new plans would have to be closely
scrutinized so as to avoid anomalous and unintended consequences (i.e., the
availability of certain benefits for persons for whom they were never intended).
Options and Constraints
Page Six
But the political obstacles to the option of designing/implementing new, less
generous and less expensive DB plans for new hires should be obvious. This
option is certain to encounter intense and unified opposition from public
employees, retirees and their organizational representatives, since it would appear
that new hires are being forced to pay disproportionately more for less generous
future benefits. Additionally, public employee organizations would be expected
to oppose any "two tier" program on the grounds that public employees should
have the benefit of equal pay and equal benefits for equal work, regardless of their
date of hire. Finally, implementation of such alternative plans would counter the
current statutorily expressed aims of the Plans, which is to provide a uniformity of
------,b'-e~n~e-rSi>R-S-Plans:-=-.··-------.-:..­For
example, the revenue from a fractional percentage increase in the State sales
tax could be dedicated for this purpose. Additionally, such a revenue subsidy
could be made contingent on the funding ratio level of the Plans. In other words,
the revenue stream would only begin to flow, once a Plan's funding ratio declined
below a statutorily prescribed level (as, for example, 85%). However, statewide
tax increases, even if designed to reduce what would otherwise be tax burdens at
the local level, are rarely popular with taxpayers or lawmakers. Therefore, this
option is probably not politically possible.
In the alternative, it might be possible to generate increased income for the Plans
by imposing new statewide fees that are appropriate and in some way related to
the services that are provided by some or all of the covered participants of the
PSPRS Plans. At a minimum, existing fees (as, for example, state filing fees that
generate some income for the EORP) could be increased; this would be of benefit
to at least some participating employers.
2. Increasing the Actuarial Interest Rate Assumption
Theoretically, the actuarial rate of return assumption for the PSPRS Plans could
be restored to 9% from the current rate of 8.5% on the grounds that, over the last
two fiscal years (i.e., FY'04 and FY'05) the actual rates of return for the Plans
were in excess of 9%. This would have the effect of lowering the state's future
contribution requirements.
However, since actuarial assumptions should reflect the System's longer-term
experience, it would be inappropriate to restore the assumption to 9% at this time,
based only on the experience of the last two fiscal years. Despite two years'
worth· of better than expected returns, the preceding three fiscal years were
marked by rates of return that were below expectations. In addition, the financial
markets have not been generating the kind of routinely robust returns that
characterized them during the last half of the 1990's.
Options and Constraints
Page Eleven
At most, it might be appropriate for the PSPRS Fund Manager to maintain the
current (FY'06) 8.5% actuarial rate of return assumption and postpone any further
one quarter of one percent annual reductions until the System has acquired more
time to experience the level of returns likely to be generated in the post-200l
through 2002 financial market environment.
3. Increasing Employee Contribution Rates
It could be argued that employees participating in at least two of the three PSPRS
__~ ~~P=l=an=:;-s-;:ar=-:e~not currently cOlltri1:>lltingtlleir fair shar~ of the financial support that is
needed. In the case ortnePSPR~Pian, rlfe=sfatutory=empIOyee=rate1s~6iil~65%;---~--~-~-~----~ ----
which is less than one-half of the Plan's FY'05 normal cost of 18.36%. It is also
much less than the FY'07 aggregate employer contribution rate of 17.12%, which
is based on the Plan's FY'05 results. In the case of the EaRP, the statutory
employee rate is 7.0%; that is less than one quarter of the Plan's FY'05 normal
cost of 29.57% and less than one-third of the FY'07 employer contribution rate,
which is based on the Plan's FY'05 results.
In the case of the CORP, however, the employee-employer contribution rate
distribution is significantly different from those in PSPRS and EaRP. The CORP
statutory employeerate is 8.5%, which is more than one-half the Plan's FY'05
normal cost of 15.03%. It is also more than the FY'07 aggregate employer
contribution rate, which is only 7.06%. Nevertheless, the currently scheduled
CORP FY'07 employer contribution rate is over 400% greater than what it was in
CORP FY'03 (i.e., 1.71 %).
The System's actuary has calculated that everyone percent increase in the
employee contribution rate would increase the funding ratio by %, in the case
of PSPRS, %, the case of the EaRP, and %, in the case of the CORP (See
Attachment G). Concomitantly, everyone percent increase in the employee
contribution rate would decrease the FY'07 employer rate by percent. It is
unclear whether a challenge on constitutional grounds to an employee
contribution rate increase would probably not be successful. Even if an employee
rate increase is constitutionally authorized, however, an increase in rates for the
Plans' participants would likely be opposed by the public employee groups and
the organizations that represent them. Participants will argue that they will
receive no additional "value" (i.e. no improvement in benefits) for their increased
contributions and they will also argue--and correctly--that when times were good
~ and the Plans had excess assets, those excess assets served to subsidize the
employers, whose contribution rates were abnormally understated. The employees
did not benefit at all in this regard, except to the extent that the buildup of excess
assets strengthened the Plans as a whole. On the other hand, given how low
employee contribution rates are, especially in the case of PSPRS and the EaRP,
---------
Options and Constraints
Page Twelve
relative to the FY'05 nonnal cost percentages for the Plans (which are the best
indicator of the worth or value of the Plans' benefit structures), the constituent
employee groups and their representative organizations might be willing to accept
additional employee contributions to remain actuarially sound or because such
increased contributions are coupled with some perceived improvement in the mix.
of the benefits of the Plans (See below for further discussion).
In the case of the CORP, the implementation of a DROP, authorized by statute
and low in cost (if this is possible), might be sufficient to obtain participant
- willingness to. accept a _cO!J.IDbutioll rate i llcrease.However, _tilis would require
participant organization support, SInce It woulQ necessarUTentaiFa=-cliarige=in---tlie-:~----------- --­CORP
statutes.
4. Assess Contributions with respect to Compensation Paid to PSPRS DROP
Participants
Under Subsec. A of Sec. 38-844.06, neither employee nor employer contributions
are assessed with respect to compensation paid to DROP participants while they
remain employed but are participating in the program for which they made an
irrevocable election. Certainly a statutory imposition of an employee contribution
requirement could be made in the case of newly hired employees. Less certain is
whether such a change would survive a constitutional challenge if it were applied
to current PSPRS Plan participants who have not yet elected DROP. But with
respect to current DROP participants, the imposition of an employee contribution
requirement would not likely survive a constitutional challenge; moreover, such a
change would be contested on contract grounds, since it would amount to an after­the-
fact changing of the rules on the basis of which the DROP election was made
and since the current DROP participants would earn no improvement in their
pension benefit amounts.
Less clear are the consequences for PSPRS covered employers, if they were
required to contribute to the Plan, based on the compensation they pay to DROP
participants. Clearly, in the case of employers with current DROP participants,
they would be assessed contributions on 100% of payroll paid to PSPRS
participants. The Plan would experience an increase in contribution income,
which, in turn, would result in some improvement in the Plan's funding ratio and
some diminishment in the aggregate employer contribution rate. However,
whether an individual employer would experience a net increase or decrease in
total dollar PSPRS contributions would probably vary depending on the size of
each employer's DROP participant group and the amount of compensation paid to
that group. The System's actuary could provide the projections necessary to
define the consequences of this possible policy change. (See Attachment H) In
Options and Constraints
Page Thirteen
addition, we would need to research whether the change is permissible under the
Internal Revenue Code.
5. Increase the Employer Contribution Minimum Rate
Currently, the minimum employer contribution requirement as set by statute for
the three PSPRS-administered Plans is 5%. Since the aggregate employer rate
scheduled for FY'07 is well above this minimum 5% floor, legislation could be
enacted to increase the contribution to a higher percentage (perhaps 6% in the
case of CORP, 8%in the case of PSl)RS_and10% in the case of EORP).
While this would not produce any additionail.~coniefbrfijese-two:::::Plans=tn.=tfiec-- ---------------------------
near term, it might have a beneficial effect on Plan revenues in the future,
assuming aggregate employer contribution rates decline from currently projected
levels.
6. Recapture Benefits Through the State Income Tax and Earmark the Revenue
for the PSPRS Plans
In the early 1980's, a special comrmSSlOn on social security under the
chairmanship of Allan Greenspan developed a set of proposals that were designed
to rescue social security's OASDI programs from impending insolvency. One of
the elements of that set of proposals (all of which were enacted by the U.S.
Congress) required the inclusion of a portion of social security payments in gross
income for federal income tax purposes. (Prior to that, social security payments
had been tax exempt.) The additional federal revenue was then earmarked for
payment back into the social security trust funds.
Here in Arizona, paragraph 2b of Sec. 43-1022 of the state income tax laws could
be changed to eliminate or reduce the (up to) $2,500 subtraction allowed for
Plans' pension payments in the calculation of adjusted gross income, with the
revenues raised thereby earmarked for the Plans that paid the benefits. In effect,
this would amount to a back door (i.e., via the state income tax structure) benefits
recapture program. However, any such tax law change would certainly be
resisted legislatively by the public employee groups and likely be challenged on
constitutional grounds as a back door diminishment of benefits.
More broadly, all pension payments and other forms of retirement income (both
public and private) could be made subject to the state income tax without any
subtraction allowed in calculating adjusted gross income, with the revenue
earmarked back to the state public retirement systems in proportion to their
respective unfunded liabilities. However, this would certainly be perceived as a
Options and Constraints
Page Fourteen
tax increase and that would be strongly resisted by the state's retirees and their
representative organizations.
7. Marking to Market PSPRS Plan Real Estate and Other Alternative
Investments
It has been the long-standing practice at PSPRS to carry the real estate and other
alternative investments of the three Plans at cost until such time as income is
realized. While the percentage of total Plan assets represented by such
iny~stments· varies. from time-to-:time,. they pmlJlll:>ly~()nsgtuteabout five percent
of each Plan's assets on average. ~ .... _._. - . - ------
Two questions are therefore presented. First, could such investments be marked to
market in some way or, at least, could values more realistic than cost be assigned
and up-dated periodically? Second, if more realistic values could be determined
for this class of investments, would that significantly increase the Plans' actuarial
value of assets and their respective funding ratios and thus reduce what would
otherwise be the projected FY'07 employer contribution requirement? The
PSPRS investment staff will provide answers to these questions. (See Attachment
I)
8. Re-examine the Treatment of the Assets in the PSPRS Plans' Future Benefits
Increase Reserves
Under current law, all three PSPRS-administered plans provide for post­retirement
adjustments. However, actual adjustments are contingent on each
Plan's having assets in its Future Benefits Increase Reserve sufficient to cover the
cost of funding each year's increase. The methodology for calculating the amount­of
the increase is specified in each Plan's statutes, but in no event can the increase
exceed 4% per year. (As a practical matter, given the significant accumulation of
excess assets in each Plan's Reserve, the recent increases have been 4% annually.)
The Reserve assets are accumulated as follows: With respect to PSPRS and the
CORP, one-half of the asset value represented by each Plan's rate of return in
excess of 9% is allocated to each Plan's Reserve (along with any subsequent
return generated on the Reserve account balance). In the case of EaRP, all the
asset value represented by the Plan's rate of return in excess of 9% is allocated to
the Plan's Reserve.
None of the assets contained in the three Reserves are counted in the calculation
of the Plan's actuarial value of assets. In effect, for the calculation of the Plan's
Options and Constraints
Page Fifteen
funding ratio (and the required employer contribution that is determined based on
the Plan's funding status), these assets are treated as if they do not exist.
On the other hand, because the annual post-retirement adjustments are fully
funded whenever they occur, the actuary does not factor into the calculation of the
Plan's future liability, any amount for future benefit increases, since they
represent only a contingent liability and, whenever they occur, they are fully
funding.
-Nevertheless,historically,giveneaGh_flaI1'_s_:ra-1~s_Qt!~tllill, the acclllllulation of
assets to fund post-retirement adjustments hasoeen moretlian--wlf:n=-~lrifs=beerrri---- --~~
needed. That explains the build-up in the amounts in the Plans' respective
Reserves.
The issue presented for actuarial analysis and for policy decision-making is this:
What would be the effect of a change in the law that folded the Reserve assets
into the calculation of each Plan's actuarial value of assets while avoiding any
possible constitutionally impermissible impairment or diminishment of post­retirement
benefit adjustments for current beneficiaries and participants? First, of
course, if the Reserve assets were no longer segregated, the actuary would have to
factor in an annual addition to each Plan's liability in an amount sufficient to
provide for an annual increase, since the post-retirement adjustments would cease
to be contingent on the availability of Reserve assets. Second, the post-retirement
adjustment methodologies would have to remain unchanged, except with respect
to the annual increase percentage limit. That would have to be lowered to avoid a
net increase in the liabilities of the Plans. (In effect, Plan beneficiaries and
participants would be trading a contingent benefit increase for an annual,
constitutionally guaranteed benefit increase, albeit one the has a percentage
maximum lower than the current 4%.)
But what would be the effect on the current financial status of each Plan? We
know that, in the past, the accumulated Reserve assets have been more than
sufficient to finance the adjustments that have occurred. But now, the Plans are
assuming future rates of return that are less than the 9% threshold that must be
reached in order for there to be an allocation of new assets to the Reserves. If the
9% threshold were reduced to whatever the actuarial assumed rate of return is (as
set by the Fund Manager), clearly the current financial status of the Plans would
deteriorate further. On the other hand, if the 9% threshold is preserved but no new
assets flow into the Reserves or if the flow is insufficient to cover the annual
adjustment costs, then the Reserves will eventually be drawn down and annual
post retirement adjustments will cease. Additionally, the System's actuary is
going to have to factor in an additional liability amount to account for an annual
Options and Constraints
Page Sixteen
post-retirement adjustment that is subject to a percentage maximum that assures a
net improvement in the Plans' financial condition.
These questions should be referred to the System's actuary for analysis. (See
Attachment J) But if it is determined that a change in the treatment of Plan
Reserve assets improves the current financial status of the Plans (and reduces
what will otherwise be the required FY'O? employer contributions) and the
beneficiaries and participants get the benefit of a pennanent, annual and
constitutionally guaranteed post-retirement adjustment, then the concept may
-- --="~"gha~v~ecm!J,""'e~ri:'o:~tsu':l:':fficientto refer ittQSlaty_ PplicYlJ:!~~rsand the Plan's constituency
groups and their respective organizations. Ihe perceivi